Bradley Pharmaceuticals 10Q 2007 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

|X|

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007
OR

|_|

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from to
Commission file number 1-31680

BRADLEY PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE	22-2581418
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

383 Route 46 W., Fairfield, NJ	07004
(Address of principal executive offices)	(Zip Code)

(973) 882-1505

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_|

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer |_| Accelerated filer |X| Non-Accelerated filer |_|

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|

As of November 2, 2007, there were outstanding 16,523,332 shares of common stock, $.01 par value, and 429,752 shares of Class B common stock, $.01 par value.

BRADLEY PHARMACEUTICALS, INC.

Table of Contents

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2007 (unaudited) and December 31, 2006	3
Consolidated Statements of Income (Loss) (unaudited) for the Three and Nine Months Ended September 30, 2007 and 2006	5
Consolidated Statement of Stockholders’ Equity (unaudited)
for the Nine Months Ended September 30, 2007	6
Consolidated Statements of Cash Flows (unaudited) for the Nine
Months Ended September 30, 2007 and 2006	7
Notes to the Consolidated Financial Statements	9
Item 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations	30
Item 3. Quantitative and Qualitative Disclosures About Market Risk	65
Item 4. Controls and Procedures	65
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	66
Item 1A. Risk Factors	68
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	70
Item 3. Defaults Upon Senior Securities	70
Item 4. Submission of Matters to a Vote of Security Holders	70
Item 5. Other Information	70
Item 6. Exhibits	70
SIGNATURES	71
CERTIFICATIONS

Part I. Financial Information

Item 1. Financial Statements

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	September 30, 2007 (unaudited)	December 31, 2006 (a)
Assets
Current assets:
Cash and cash equivalents	$ 10,117,124	$ 39,608,987
Short-term investments	3,008,881	7,083,678
Accounts receivable, net of allowances	11,439,344	14,489,623
Inventories, net	9,947,456	6,881,218
Deferred tax assets	14,158,203	13,332,666
Prepaid expenses and other	2,184,373	2,100,487
Prepaid income taxes	3,076,307	4,934,119

Total current assets	53,931,688	88,430,778

Property and equipment, net	1,108,840	813,794
Intangible assets, net	157,707,056	165,985,767
Goodwill	27,478,307	27,478,307
Deferred financing costs, net	1,125,167	4,798,034
Restricted cash and investments	-	25,000,000
Other assets	16,229	16,229

Total assets	$241,367,287	$312,522,909

(a) Derived from audited financial statements.

See accompanying notes to consolidated financial statements.

(Continued)

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	September 30, 2007 (unaudited)		December 31, 2006 (a)
Liabilities
Current liabilities:
Current maturities of long-term debt	$ —		$ 15,660,085
Milestone payable - ELESTRIN™	3,252,145		10,115,083
Accounts payable	7,319,796		4,948,754
Accrued expenses	36,771,110		38,728,413

Total current liabilities	47,343,051		69,452,335

Long-term liabilities:
Long-term debt, less current maturities	—-		53,400,000
Deferred tax liabilities	1,728,612		2,054,145

Total long-term liabilities	1,728,612		55,454,145

Stockholders’ Equity
Preferred stock, $0.01 par value; shares authorized:
2,000,000; issued - none	—		—
Common stock, $0.01 par value; authorized: 26,400,000 shares;
issued 17,398,557 shares at September 30, 2007 and
16,965,578 shares at December 31, 2006	173,986		169,656
Class B common stock, $0.01 par value; shares authorized:
900,000; issued 429,752 shares at September 30, 2007 and
at December 31, 2006	4,298		4,298
Additional paid-in capital	148,318,735		139,754,887
Retained earnings	47,089,742		50,977,625
Accumulated other comprehensive gain	43		1,143
Treasury stock - common stock - at cost; 877,058 shares at
September 30, 2007 and December 31, 2006	(3,291,180	)	(3,291,180	)

Total stockholders’ equity	192,295,624		187,616,429

Total liabilities and stockholders’ equity	$ 241,367,287		$ 312,522,909

(a) Derived from audited financial statements.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Net sales	$ 33,553,145		$ 35,204,765		$ 103,514,742		$ 107,107,882
Cost of sales (1)	6,272,691		5,725,395		19,630,009		16,491,794

	27,280,454		29,479,370		83,884,733		90,616,088

Selling, general and administrative	21,427,540		18,680,456		65,713,828		57,612,042
Research and development	1,686,927		339,630		3,316,873		6,109,971
Depreciation and amortization	2,900,122		2,498,676		8,757,565		7,578,150
Interest income	(275,534	)	(701,133	)	(1,505,892	)	(1,761,586	)
Interest expense	731,781		2,133,392		5,284,180		6,331,499
Write-off of deferred financing costs	3,256,280		—		3,256,280		—

	29,727,116		22,951,021		84,822,834		75,870,076

Income (loss) before
income tax expense (benefit)	(2,446,662	)	6,528,349		(938,101	)	14,746,012
Income tax expense (benefit)	(1,207,211	)	2,742,000		(550,327	)	6,193,000

Net income (loss)	$(1,239,451	)	$ 3,786,349		$ (387,774	)	$ 8,553,012

Basic net income (loss) per common share	$ (0.07	)	$ 0.23		$ (0.02	)	$ 0.52

Diluted net income (loss) per common share	$ (0.07	)	$ 0.23		$ (0.02	)	$ 0.52

Shares used in computing basic net income per common share	16,950,000		16,430,000		16,810,000		16,400,000

Shares used in computing diluted net income per common share	16,950,000		16,540,000		16,810,000		16,520,000

(1) Amounts exclude amortization of intangible assets related to acquired products.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

	Common stock, $.01 par value		Class B common stock, $.01 par value		Additional paid-in capital	Accumulated other comprehensive gain (loss)		Retained earnings		Treasury stock			Total
	Shares	Amount	Shares	Amount	Additional paid-in capital	Accumulated other comprehensive gain (loss)		Retained earnings		Shares	Amount		Total
Balance at December 31, 2006 (1)	16,965,578	$169,656	429,752	$4,298	$139,754,887	$1,143		$50,977,625		877,058	$(3,291,180	)	$ 187,616,429
Cumulative effect of adopting
FIN 48, net of tax (2)								(3,500,109	)				(3,500,109	)

Balance at January 1, 2007	16,965,578	169,656	429,752	4,298	139,754,887	1,143		47,477,516		877,058	(3,291,180	)	184,116,320
Stock options exercised (3)	432,979	4,330			6,170,848								6,175,178
Non-cash share based compensation					2,393,000								2,393,000
Other comprehensive loss:
Net loss								(387,774	)				(387,774	)
Net unrealized loss on
available-for-sale securities						(1,100	)						(1,100	)

Total comprehensive loss													(388,874	)

Balance at September 30, 2007	17,398,557	$173,986	429,752	$4,298	$148,318,735	$43		$47,089,742		877,058	$(3,291,180	)	$ 192,295,624

(1)

Derived from audited financial statements.

(2)

For more information see NOTE C – Adoption of New Accounting Standards.

(3)

Amounts include tax benefits resulting from the exercise of stock options of $968,299 for the nine months ended September 30, 2007.

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

	Nine Months Ended
	September 30, 2007		September 30, 2006
Cash flows from operating activities:
Net income (loss)	$ (387,774	)	$ 8,553,012
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization	8,757,565		7,578,150
Amortization of deferred financing costs	1,072,346		981,197
Write-off of deferred financing costs	3,256,280		—
Deferred income taxes	410,658		987,297
Increase (decrease) in allowance for
doubtful accounts	(224,693	)	576,308
Increase (decrease) in return reserve	(3,851,297	)	599,974
Increase in inventory valuation reserve	2,213,272		121,306
Increase (decrease) in rebate reserve	1,581,669		(1,704,178	)
Increase (decrease) in fee-for-service	(103,757	)	1,467,202
Non-cash share-based compensation expense	2,393,000		2,625,000
Changes in operating assets and liabilities:
Accounts receivable	3,378,732		883,624
Inventories	(5,279,509	)	(997,188	)
Prepaid expenses and other	(83,886	)	(411,934	)
Accounts payable	2,371,042		(2,290,537	)
Accrued expenses	449,387		2,066,225
Prepaid income taxes	(3,204,027	)	4,313,146

Net cash provided by operating activities	12,749,008		25,348,604
Cash flows from investing activities:
Sales of short-term investments- net	4,073,696		—
Release of a restriction of cash under the
$110 million credit facility	25,000,000		12,920,014
Purchases of property and equipment	(773,900	)	(59,622	)

Net cash provided by investing activities	28,299,796		12,860,392
Cash flows from financing activities:
Payment of notes payable	—		(13,131	)
Payment of the $110 million credit facility’s
term loan	(69,060,085	)	(6,000,000	)
Payment for milestone payable-ELESTRIN™	(7,000,000	)	—
Proceeds from exercise of stock options and warrants	5,206,878		286,940
Tax benefit due to exercise of non-qualified
options and warrants	968,299		125,649
Payment of deferred financing costs	(655,759	)	(775,000	)

Net cash used in financing activities	(70,540,667	)	(6,375,542	)

(Continued)

BRADLEY PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

	Nine Months Ended
	September 30, 2007		September 30, 2006
Net increase (decrease) in cash and cash equivalents	(29,491,863	)	31,833,454
Cash and cash equivalents at beginning of period	39,608,987		19,798,728

Cash and cash equivalents at end of period	$ 10,117,124		$51,632,182

Supplemental disclosures of cash flow information:

Cash paid during the period for:
Interest	$ 4,407,921		$ 5,305,198

Income taxes	$ 1,405,202		$ 780,190

As of January 1, 2007, the Company recorded increases in income taxes payable of $5,061,838 and long-term deferred tax assets of $1,561,729 and a decrease in retained earnings of $3,500,109 as a result of the adoption of FIN 48 - (See Note L).

See accompanying notes to consolidated financial statements.

BRADLEY PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE A -Basis of Presentation

The accompanying unaudited interim consolidated financial statements of Bradley Pharmaceuticals, Inc. and Subsidiaries (the “Company”, “Bradley”, “we” or “us”) have been prepared in accordance with accounting principles generally accepted in the United States of America and rules and regulations of the United States Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring entries) necessary to present fairly the Company’s financial position as of September 30, 2007, its results of operations for the three and nine months ended September 30, 2007 and 2006 and cash flows for the nine months ended September 30, 2007 and 2006.

The accounting policies followed by the Company are set forth in NOTE A of the Company’s consolidated financial statements as contained in its Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

The results reported for the three and nine months ended September 30, 2007 are not necessarily indicative of the results of operations that may be expected for a full year.

NOTE B -Proposed Merger with Nycomed US Inc.

On October 29, 2007, we entered into a definitive merger agreement (the “Merger Agreement”) with Nycomed US Inc. (“Nycomed US”) and Phase Merger Sub Inc., a wholly owned subsidiary of Nycomed US (“Merger Sub”). Nycomed US is an indirect subsidiary of Nycomed S.C.A., SICAR. The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company (the “Merger”), with the Company continuing as the surviving corporation. Upon consummation of the Merger, the Company will become a wholly owned subsidiary of Nycomed US. At the effective time of the Merger, all shares of the Company’s common stock, par value $.01 per share, and Class B common stock, par value $.01 per share, then outstanding (other than shares as to which dissenters’ rights have been properly exercised) will be converted into $20.00 per share in cash.

course consistent with past practice; (ii) subject to our Board of Directors’ right to exercise its fiduciary duties, covenants restricting the solicitation of competing acquisition proposals; and (iii) covenants relating to obtaining the required approval of our stockholders. The transaction is conditioned on receipt of approval by holders of a majority of the outstanding shares of our common stock and Class B common stock, voting together as one class. The transaction is also subject to the expiration or termination of applicable waiting periods under United States and foreign anti-trust laws and other customary closing conditions. There is no financing condition, and the obligations of Nycomed US are guaranteed by Nycomed S.C.A., SICAR. The terms of the Merger Agreement include provisions prohibiting us from soliciting an alternate takeover proposal from a third party, or entering into negotiations or discussions regarding an alternate proposal unless such proposal is deemed to be a “Superior Proposal” (as defined in the Merger Agreement) by our Board of Directors by a vote of a majority of the disinterested Directors. It also includes a termination fee equal to 3% of the Merger Consideration (as defined in the Merger Agreement) to be paid by us to Nycomed US if the Merger Agreement is terminated under specified circumstances. This description of certain terms of the Merger Agreement and the Guaranty of Nycomed S.C.A., SICAR and the transactions contemplated by the Merger Agreement and such Guaranty is qualified in its entirety by reference to the full text of the Merger Agreement and the Guaranty, copies of which were filed as exhibits to our Current Report on Form 8-K filed on October 30, 2007.

On May 29, 2007, the Company announced that its Board of Directors had received a proposal on that date from a group of investors led by Daniel Glassman, founder, director, President and CEO of the Company and the holder of nearly all of the Company’s Class B common stock, to acquire all of the outstanding shares of Bradley common stock and Class B common stock for $21.50 per share in cash. The Bradley Board of Directors formed the Special Committee of independent directors to consider the Company’s strategic alternatives, including Mr. Glassman’s proposal. Since May 29th, the Special Committee, advised by independent financial and legal advisors, engaged in an extensive auction process. Based on the recommendation of the Special Committee, the Board of Directors of Bradley approved the Merger Agreement and recommended that Bradley’s stockholders vote in favor of the Merger Agreement. Mr. Glassman did not participate in the Board’s consideration and approval of the Merger Agreement.

The transaction is expected to be completed in the first quarter of 2008 although we cannot assure you that it will close. For more information about the proposed transaction, refer to our Current Report on Form 8-K filed on October 30, 2007. We intend to file a proxy statement with the SEC that, when final, will contain details for a meeting of our stockholders to enable our stockholders to vote to adopt the Merger Agreement. The proxy statement will be sent to all our stockholders and will contain important information about us, the merger, risks relating to the merger and related matters. We strongly encourage our stockholders to read this proxy statement when available.

In July 2007, the Board of Directors approved the acceleration of the vesting of all employee options upon a change in control (as defined) and an employment retention plan that provides for cash retention bonuses to key employees (other than the executive officer of the Company) following a change in control.

NOTE C -Adoption of New Accounting Standards

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. This interpretation is effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 resulted in an opening retained earnings adjustment of $3,500,000 (See NOTE L - Income Taxes).

In June 2006, the Emerging Issues Task Force (“EITF”) issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” EITF Issue 06-3 provides guidance related to the presentation in financial statements of any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, including, but not limited to, sales, use, value added, and some excise taxes. The EITF concluded that the presentation of taxes within the scope of EITF Issue 06-3 on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. In addition, the aggregate amount of any such taxes that are reported on a gross basis should be disclosed in interim and annual financial statements. The guidance in EITF Issue 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF Issue 06-3 did not have a material impact on the Company’s consolidated financial statements.

NOTE D -Net Income (Loss) Per Common Share

Basic net income (loss) per common share is determined by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted net income (loss) per common share is determined by dividing net income (loss) by the weighted number of shares outstanding adjusted for dilutive common equivalent shares from stock options and warrants. A reconciliation of the weighted average basic common shares outstanding to weighted average diluted common shares outstanding is as follows:

	Three Months Ended			Nine Months Ended
	September 30, 2007		September 30, 2006	September 30, 2007		September 30, 2006
Basic shares	16,950,000		16,430,000	16,810,000		16,400,000
Dilution:
Stock options and warrants	—		110,000	—		120,000

Diluted shares	16,950,000		16,540,000	16,810,000		16,520,000

Net income (loss) as reported	$(1,239,000	)	$ 3,786,000	$ (388,000	)	$ 8,553,000

Basic income (loss) per share	$ (0.07	)	$ 0.23	$ (0.02	)	$ 0.52

Diluted income (loss) per share	$ (0.07	)	$ 0.23	$ (0.02	)	$ 0.52

In addition to stock options and warrants included in the above computation for the three and nine months ended September 30, 2007, respectively, options to purchase 320,784 and 191,600 shares of common stock at prices ranging from $18.96 to $27.12 and $20.18 to $27.12 per share, respectively, were outstanding and not included for the purpose of calculating per share amounts. Further, in addition to stock options and warrants included in the above computation for both the three and nine months ended September 30, 2006, options to purchase 1,403,901 shares of common stock at prices ranging from $12.86 to $27.12 per share were outstanding and not included. These options were excluded from the calculation of diluted earnings per share for the applicable periods because the exercise price of the option was greater than the average market price of the common stock during those periods. In addition, as a result of the Company’s net loss during the three and nine months ended September 30, 2007, stock options and warrants to purchase 88,404 and 105,000 shares of common stock with exercise prices less than the average stock price during the respective periods were not included because of the anti-dilutive impact on the calculation.

Note E –Comprehensive Income (Loss)

Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income”, requires that items defined as other comprehensive income, such as net income and unrealized gains and losses on available-for-sale securities, be reported separately in the financial statements. The components of comprehensive income (loss) for the three and nine months ended September 30, 2007 and 2006 are as follows:

	Three Months Ended			Nine Months Ended
	September 30, 2007		September 30, 2006	September 30, 2007		September 30, 2006
Net income (loss)	$(1,239,000	)	$3,786,000	$(388,000	)	$8,553,000
Other comprehensive income (loss):
Net unrealized gain (loss) on
available for sale securities	—		2,000	(1,000	)	4,000

Comprehensive income (loss)	$(1,239,000	)	$3,788,000	$(389,000	)	$8,557,000

Note F –Business Segment Information

The Company’s three reportable segments are Doak Dermatologics (dermatology and podiatry), Kenwood Therapeutics (gastrointestinal, women’s health, respiratory, nutritional and other) and A. Aarons (generic), which began operations in the Second Quarter of 2006. Each segment has been identified by the Company to be a distinct operating unit distributing different pharmaceutical products. Doak Dermatologics’ products are marketed, promoted and distributed primarily to physicians practicing in the fields of dermatology and podiatry; Kenwood Therapeutics’ products are marketed, promoted and distributed primarily to physicians practicing in the field of internal medicine/ gastroenterology and women’s health; and A. Aarons’ products are the generic version of some of our Doak Dermatologics’ and Kenwood Therapeutics’ products.

The accounting policies used to develop segment information correspond to those described in the summary of significant accounting policies in the notes to the financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The reportable segments are distinct business units with no inter-segment sales. The following information about the three segments is for the three and nine months ended September 30, 2007 and 2006:

	Three Months Ended				Nine Months Ended
	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
Net sales:
Doak Dermatologics, Inc.	$ 25,967,000		$ 27,238,000		$ 78,898,000		$ 84,421,000
Kenwood Therapeutics	6,199,000		7,967,000		21,974,000		22,687,000
A. Aarons	1,387,000		—		2,643,000		—

	$ 33,553,000		$ 35,205,000		$ 103,515,000		$ 107,108,000

Depreciation and amortization:
Doak Dermatologics, Inc.	$ 2,436,000		$ 2,226,000		$ 7,355,000		$ 6,718,000
Kenwood Therapeutics	464,000		273,000		1,403,000		860,000
A. Aarons	—		—		—		—

	$ 2,900,000		$ 2,499,000		$ 8,758,000		$ 7,578,000

Income (loss) before income tax
expense (benefit):
Doak Dermatologics, Inc.	$ 77,000		$ 6,346,000		$ 1,653,000		$ 12,993,000
Kenwood Therapeutics	(2,590,000	)	305,000		(2,694,000	)	1,876,000
A. Aarons	66,000		(123,000	)	103,000		(123,000	)

	$(2,447,000	)	$ 6,528,000		$ (938,000	)	$ 14,746,000

Income tax expense (benefit):
Doak Dermatologics, Inc.	$ 283,000		$ 2,665,000		$ 970,000		$ 5,457,000
Kenwood Therapeutics	(1,535,000	)	128,000		(1,581,000	)	787,000
A. Aarons	44,000		(51,000	)	61,000		(51,000	)

	$(1,208,000	)	$ 2,742,000		$ (550,000	)	$ 6,193,000

Net income (loss):
Doak Dermatologics, Inc.	$ (206,000	)	$ 3,681,000		$ 683,000		$ 7,536,000
Kenwood Therapeutics	(1,055,000	)	177,000		(1,113,000	)	1,089,000
A. Aarons	22,000		(72,000	)	42,000		(72,000	)

	$(1,239,000	)	$ 3,786,000		$ (388,000	)	$ 8,553,000

Geographic information (revenues):
Doak Dermatologics, Inc.
United States	$ 25,283,000		$ 26,685,000		$ 76,849,000		$ 82,587,000
Other countries	684,000		553,000		2,049,000		1,834,000

	$ 25,967,000		$ 27,238,000		$ 78,898,000		$ 84,421,000

Kenwood Therapeutics
United States	$ 6,072,000		$ 7,807,000		$ 21,470,000		$ 22,268,000
Other countries	127,000		160,000		504,000		419,000

	$ 6,199,000		$ 7,967,000		$ 21,974,000		$ 22,687,000

A. Aarons
United States	$ 1,387,000		$ —		$ 2,643,000		$ —
Other countries	—		—		—		—

	$ 1,387,000		$ —		$ 2,643,000		$ —

Net sales by category:
Dermatology and podiatry	$ 25,967,000		$ 27,238,000		$ 78,898,000		$ 84,421,000
Gastrointestinal	4,027,000		7,217,000		15,535,000		19,769,000
Respiratory	1,536,000		453,000		3,986,000		1,778,000
Nutritional and other	636,000		297,000		2,453,000		1,140,000
A. Aarons	1,387,000		—		2,643,000		—

	$ 33,553,000		$ 35,205,000		$ 103,515,000		$ 107,108,000

	September 30, 2007	December 31, 2006
Total Assets:
Doak Dermatologics, Inc.	$178,523,000	$185,291,000
Kenwood Therapeutics	16,461,000	15,297,000
A. Aarons	1,258,000	571,000
* Unallocated assets	45,126,000	111,364,000

	$241,368,000	$312,523,000

Unallocated assets include cash and cash equivalents, short-term investments, accounts receivable, deferred tax assets, prepaid expenses and other, prepaid income taxes, deferred financing costs and restricted cash and investments.

The Company’s sales and cost of goods sold are product identifiable and recorded to each business segment by product. Additionally, certain operating expenses, such as those attributable to product marketing, are product specific and also charged directly to the product and corresponding segment. The Company allocates all other expenses that are not product identifiable to each of the segments based on a percentage of the net sales of each segment to the Company totals. Accordingly, the expense allocation percentages can differ between years depending on the segment’s proportionate share of net sales.

Note G –Short-Term Investments

The Company’s short-term investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs and delivers an appropriate yield in relationship to the Company’s investment guidelines and market conditions.

The Company invests primarily in money market funds, short-term commercial paper, short-term municipal bonds, treasury bills and treasury notes. By policy, the Company invests primarily in high-grade investments.

The following is a summary of available-for-sale securities at September 30, 2007:

	Cost	Gross Unrealized Gain/(Loss)	Fair Value
Municipal bonds	$ 3,009,000	$ —	$ 3,009,000

Total available-for-sale securities
	$ 3,009,000	$ —	$ 3,009,000

The following is a summary of available-for-sale securities at December 31, 2006:

	Cost	Gross Unrealized Gain/(Loss)	Fair Value*
Municipal bonds	$32,083,000	$ 1,000	$32,084,000

Total available-for-sale securities
	$32,083,000	$ 1,000	$32,084,000

During the three and nine months ended September 30, 2007 and 2006, the Company did not have gross realized gains or losses on investment. The net adjustments to unrealized gains/losses during the three and nine months ended September 30, 2007 on available-for-sale securities included in accumulated other comprehensive gain totaled zero and a loss of $1,000, respectively, compared to gains of $2,000 and $4,000, respectively, for the corresponding periods ended September 30, 2006. The Company views its available-for-sale securities as available for current operations.

The amortized costs and estimated fair value of the available-for-sale securities at September 30, 2007 and December 31, 2006, by maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties, and the Company views its available-for-sale securities as available for current operations.

	September 30, 2007		December 31, 2006
Available-for-sale	Cost	Estimated Fair Value	Cost	Estimated Fair Value *
Due in one year or less	$ 9,000	$ 9,000	$ 8,000	$ 9,000
Due after one year through two years	—	—	—
Due after two years	3,000,000	3,000,000	32,075,000	32,075,000

Total	$3,009,000	$3,009,000	$32,083,000	$32,084,000

* Before application of restriction as discussed below.

As of December 31, 2006, the Company had a restriction on the ability to use a portion of its short-term investments arising from the $110,000,000 credit facility (See NOTE Q - Senior Credit Facility). The total amount of restricted cash and investments from the $110,000,000 credit facility at December 31, 2006 was $25,000,000. In August 2007, the Company used the restricted cash, along with a portion of its cash and cash equivalents, to pay the remaining balance of $62,370,000 due under the credit facility at that time.

Note H -Accounts Receivable

The Company extends credit on an uncollateralized basis primarily to wholesaler drug distributors. Historically, the Company has not experienced significant credit losses on its accounts. Four customers accounted for an aggregate of approximately 88% of the Company’s gross trade accounts receivable at September 30, 2007. On a gross trade accounts receivable basis, Cardinal Health, Inc. (“Cardinal”) owed approximately $6,218,000 to the Company, or 40% of accounts receivable, McKesson Corporation (“McKesson”) owed approximately $5,099,000 to the Company, or 33% of accounts receivable, AmerisourceBergen Corporation (“AmerisourceBergen”) owed approximately $1,310,000 to the Company, or 8% of accounts receivable, and Kinray, Inc. (“Kinray”) owed approximately $1,084,000 to the Company, or 7% of accounts receivable. At December 31, 2006, four customers accounted for an aggregate of approximately 97% of the Company’s gross trade accounts receivable. Of these customers, Cardinal, McKesson, Kinray and AmerisourceBergen owed approximately $7,614,000, or 44%, $7,520,000, or 43%, $1,642,000, or 9% and $1,254,000, or 7%, respectively, of the gross trade accounts receivable to the Company on December 31, 2006.

The following table presents a summary of sales to the Company’s largest customers, who are wholesalers, during the three and nine months ended September 30, 2007 and 2006 as a percentage of the Company’s total gross sales:

	Three Months Ended				Nine Months Ended
Customer*	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
AmerisourceBergen Corp.	13	%	11	%	14	%	12	%
Cardinal Health, Inc.	35	%	36	%	33	%	39	%
Kinray, Inc.	6	%	4	%	5	%	4	%
McKesson Corporation	30	%	34	%	33	%	32	%

Total	84	%	85	%	85	%	87	%

* No other customer had a percentage of the Company’s total gross sales greater than 5% during the three and nine months ended September 30, 2007 and 2006.

Accounts receivable balances at September 30, 2007 and December 31, 2006 are as follows:

	September 30, 2007	December 31, 2006
Accounts receivable:
Trade	$15,333,000	$17,418,000
Other	7,000	1,380,000

	15,340,000	18,798,000

Less allowances:
Chargebacks	125,000	135,000
Discounts	324,000	392,000
Fee-for-service	1,675,000	1,779,000
Doubtful accounts	1,777,000	2,002,000

	3,901,000	4,308,000

Accounts receivable, net of allowances	$11,439,000	$14,490,000

Trade receivables consist of sales of product primarily to wholesale customers. Other receivables at December 31, 2006 primarily consist of a royalty due to the Company from Par Pharmaceuticals Companies, Inc. for the authorized generic version of ADOXA^®. As of September 30, 2007, the Company owed Par $290,000 based on Par’s profit sharing calculations, which is included in accrued expenses.

Chargebacks are based on the difference between the prices at which the Company sells its products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payors, who are often governmental agencies and managed care buying groups. The Company records an estimate of the amount to be charged back to

the Company at the time of sale to the wholesaler. The Company records reserves for chargebacks based upon various factors, including current contract prices, historical trends and the Company’s future expectations.

The Company records an estimate of the discount deducted from customer’s payments at the time of sale. Typically, the Company offers a 2% discount based upon prompt payments by the customer. Management estimates its reserves for discounts based upon historical discounts claimed.

The Company has Distribution and Service Agreements (“DSAs”) with three of its customers, McKesson, Cardinal and Kinray. DSAs are a result of the wholesalers shifting from the “buy and hold” model (i.e., wholesalers purchasing in bulk in anticipation of price increases or in exchange for discounts) to the “fee-for-service” model (i.e., where pharmaceutical providers pay wholesalers a fee for the service of distributing the pharmaceutical provider’s products) in an effort to align wholesaler purchasing patterns with end-user demand. The terms of the DSAs require the Company to pay fees to Cardinal, McKesson and Kinray, which are offset by any price appreciation of the inventory that Cardinal, McKesson and Kinray have on-hand and also by any discounts that the Company gives to Cardinal, McKesson and Kinray for new product promotions. In return, Cardinal, McKesson and Kinray are obligated to maintain their respective inventory levels of the Company’s products to the agreed upon months-on-hand and to provide the Company with monthly inventory and sales reports. The Company records fees-for-service as deductions from gross sales in its consolidated statements of income.

The Company also maintains a provision for doubtful accounts, with respect to which the Company believes the probability of collecting accounts receivable is remote. Based upon specific analysis of the Company’s accounts, the Company maintains a reserve.

The amount of actual chargebacks, discounts, fees-for service and customer defaults, as described above, could be either higher or lower than the amounts accrued by the Company. Changes in the Company’s estimates would be recorded in the income statement in the period of the change.

Note I –Inventories

The Company purchases raw materials and packaging components for some of its third party manufacturing vendors. The Company uses these third party manufacturers to manufacture and package finished goods held for sale, takes title to certain finished inventories once manufactured, and warehouses such goods until final distribution and sale. Finished goods consist of saleable products that are primarily held at a third party warehouse. Inventories are valued at the lower of cost or market using the first-in, first-out method. The Company provides valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

Inventory balances at September 30, 2007 and December 31, 2006 are as follows:

	September 30, 2007		December 31, 2006
Finished goods	$ 10,630,000		$ 6,472,000
Raw materials	2,472,000		1,351,000
Valuation reserve	(3,155,000	)	(942,000	)

Inventories, net	$ 9,947,000		$ 6,881,000

Inventories increased from year end due to the purchase of new products and the timing of purchases of existing products. Primarily as a result of our returns and inventory optimization plan, lower than anticipated sales of ELESTRIN™, generic competition on certain products and additional reserves for A. Aarons product, the Company’s inventory reserves increased $2,213,000 during the nine months ended September 30, 2007 (See - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies).

Note J -Accrued Expenses

Accrued expenses balances at September 30, 2007 and December 31, 2006 are as follows:

	September 30, 2007	December 31, 2006
Employee compensation and benefits	$ 3,209,000	$ 2,942,000
Rebate payable	77,000	2,116,000
Rebate liability	4,668,000	3,087,000
Deferred revenue	1,945,000	57,000
Return reserve	22,497,000	26,348,000
Professional fees and legal settlement reserves	1,665,000	1,680,000
Royalty payable	1,654,000	1,974,000
Interest payable	195,000	266,000
Other	861,000	258,000

Accrued expenses	$36,771,000	$38,728,000

The Company establishes and maintains reserves for amounts payable to managed care organizations and state Medicaid programs for the reimbursement of a portion of the retail price of prescriptions filled that are covered by the respective plans. The amounts estimated to be paid relating to products sold are recognized as revenue reductions and as additions to either rebate payable or rebate liability at the time of sale based on the Company’s best estimate of the expected prescription fill rate to these managed care patients using historical experience adjusted to reflect known changes in the factors that impact such reserves. The rebate liability principally represents the estimated claims for

rebates owed to Medicaid and managed care providers but not yet received by the Company. The rebate payable represents actual claims for rebate amounts received from Medicaid and managed care providers and payable by the Company.

The Company began selling generic versions of certain of its products through its A. Aarons subsidiary during the Third Quarter of 2006. Under SFAS No. 48, “Revenue Recognition When Right of Return Exists,” the Company did not recognize any revenue from these sales through the First Quarter of 2007 because it did not have sufficient historical data in order to accrue and reserve for returns of A. Aarons’ products. In addition, the prescription data at that time did not support sufficient resales to the end user and we did not have sufficient customer payments for product shipped. During 2006 and for the first nine months of 2007, A. Aarons shipped approximately $268,000 and $8,213,000, respectively, of products at each product’s respective gross selling price. In the three and nine month periods ended September 30, 2007, respectively, the Company recorded net revenues of $1,387,000 and $2,642,000 from these sales based on prescription data and cash collections, while not recording $4,395,000, at gross sales value, for the estimated product remaining in the channel at September 30, 2007. At September 30, 2007, the Company recorded $1,945,000 of deferred revenue in accrued expenses, $1,681,000 of which is related to shipments of A. Aarons’ products and represents the payments received from customers through that date on sales that were not yet recognized.

The Company records an estimate for returns at the time of sale. The Company’s return policy typically allows returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. The Company believes that it has sufficient data to estimate future returns at the time of sale. These amounts are deducted from the Company’s gross sales to determine the Company’s net sales. The Company’s estimates take into consideration both quantitative and qualitative information including, but not limited to, actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and general economic and industry wide indicators. The Company periodically reviews the reserves established for returns and adjusts them based on actual experience. If the Company over or under estimates the level of sales that will ultimately be returned, there may be a material impact to the Company’s financial statements.

The professional fees and legal settlement reserves include legal and accounting fees and the Company’s estimate for potential settlements and the resolution of contractual disagreements (see NOTE P - Commitments and Contingencies).

NOTE K -Milestone Payable

On November 7, 2006, the Company entered into an agreement (the “BioSante Agreement”) with BioSante Pharmaceuticals (“BioSante”) to market its estradiol transdermal gel, ELESTRIN™ (estradiol), in the United States. In consideration for the grant of the Company’s right to market ELESTRIN™, the Company paid BioSante and its licensor for ELESTRIN™ an aggregate of $3,500,000 during October 2006, which

was expensed as research and development during the Fourth Quarter of 2006 because there was no FDA approval of the product at that time. Subsequently on December 18, 2006, the FDA approval of ELESTRIN™ triggered milestones payable to BioSante and its licensor for ELESTRIN™ pursuant to the BioSante Agreement of $7,000,000, which was paid by the Company in March 2007, and $3,500,000 due in December 2007. The milestones payable are non-interest bearing. At December 31, 2006, the Company utilized an imputed interest rate of 7.35% to determine the principal owed at that time of $10,115,000, which was recorded as a milestone payable and corresponding intangible asset. At September 30, 2007, the milestone payable was $3,252,000 following the Company’s first quarter payment of $7,000,000.

Note L -Income Taxes

The provision for income taxes reflects management’s estimate of the effective tax rate expected to be applicable for the full fiscal year.

Deferred income taxes are provided for the future tax consequences attributable to the differences between the financial statement carrying amounts of assets and liabilities and their respective tax base. Deferred tax assets are reduced by a valuation allowance when, in the Company’s opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. On September 30, 2007 and December 31, 2006, the Company determined that no deferred tax asset valuation allowance was necessary. The Company believes that its projections of future taxable income make it more likely than not that such deferred tax assets will be realized. If the Company’s current projection of future taxable income changes, the Company may be required to reduce deferred tax assets by a valuation allowance.

The Company adopted the provisions of FIN 48 on January 1, 2007. Previously, the Company had accounted for tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies.” As required by FIN 48, which clarifies SFAS No. 109, “Accounting for Income Taxes,” the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. At the adoption date, the Company applied FIN 48 to all tax positions for which the statute of limitations remained open, which included years 2002 through 2006. As a result of the implementation of FIN 48, the Company recognized increases of $5,062,000 in income taxes payable for unrecognized tax liabilities and $1,562,000 in long-term deferred tax assets and a decrease of $3,500,000 in retained earnings at January 1, 2007.

The Company’s FIN 48 adjustment includes approximately $1,155,000 for the payment of interest and penalties at January 1, 2007. Subsequent changes to accrued interest and penalties have not been significant. The Company’s policy is to recognize interest and penalties accrued on uncertain tax positions as part of income tax expense.

Pursuant to FIN 48, the Company recognized in its income tax provisions income tax expense of $13,000 and an income tax benefit of $403,000, net of related federal and state tax benefits, for the three and nine months ended September 30, 2007, respectively, because the statute of limitations expired related to certain tax positions taken by the Company without the relevant taxing authority examining the applicable returns. These amounts were partially offset by additional tax exposures, interest and penalties resulting in a benefit of $125,000 for the three months ended September 30, 2007 and expense of $307,000 for the nine months ended September 30, 2007, net of related federal and state tax benefits, related to all tax positions for which the statute of limitations remained open.

The Company is subject to income taxes in the U.S. federal jurisdiction and in various states and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply.

The Company is currently under examination by several state jurisdictions for periods prior to 2007. The Company expects those examinations to be concluded in the next 12 months. Additionally, the statute of limitations in some jurisdictions will expire in the next 12 months.

As a result of the adoption of FIN 48 and the effect of permanent tax differences on a smaller taxable base, the Company’s effective tax rate for the three and nine months ended September 30, 2007 was approximately 49% and 59%, respectively. The Company’s effective tax rate was estimated to be approximately 42% for the three and nine month periods ended September 30, 2006. The Company’s effective tax rate increased with the adoption of SFAS No. 123R in 2006, since expensing qualified (incentive) stock options results in a permanent tax difference.

Note M -Incentive and Non-Qualified Stock Option Plan

The Company’s 1990 Stock Option Plan and its 1999 Incentive and Non-Qualified Stock Option Plan are described more fully in Note B of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. A summary of the Company’s stock option activity during the nine months ended September 30, 2007 and 2006 is as follows:

	2007					2006
	Number of Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value	Number of Options		Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Outstanding, January 1	1,651,717		$13.95			1,875,189		$13.76

Granted	188,550		20.01			86,700		11.56
Exercised	(432,979	)	12.03			(55,000	)	5.22
Canceled or forfeited	(195,279	)	17.23			(151,889	)	17.43

Outstanding Sept. 30	1,212,009		$15.05	6.83	$4,911,000	1,755,000		$13.90	6.23	$5,236,000

Vested and expected to
vest, Sept. 30	1,083,988		$14.99	6.67	$4,515,000	1,581,702		$13.79	6.09	$4,780,000

Exercisable, Sept. 30	506,001		$14.89	5.82	$2,516,000	724,095		$13.68	3.56	$2,789,000

There were 432,979 and 55,000 options exercised during the nine month periods ended September 30, 2007 and 2006, respectively, the total intrinsic values of which were approximately $3,133,000 and $320,000 for the respective periods. Additionally, the weighted average, grant date fair value of options granted during the nine months ended September 30, 2007 and 2006, respectively, was approximately $9.24 per share and $6.66 per share, using the Black-Scholes Option Valuation Model.

The Company used the Black-Scholes Option Valuation Model to estimate the fair value of stock options granted in 2007 and 2006 for purposes of recording stock compensation expense pursuant to the provisions of SFAS No. 123R (“SFAS No. 123R”), “Share-Based Payment,” and SEC Staff Accounting Bulletin (“SAB”) No. 107. Key input assumptions used to estimate the fair value of stock options include the expected term until the exercise of the option, expected volatility of the Company’s stock, the risk free-rate of return, option forfeiture rates, and dividends, if any. The expected term of the options is based on the historical weighted average exercise behavior of officers and non officers. The expected volatility is derived from the historical volatility of the Company’s stock on the secondary markets. The risk-free interest rate is the yield from a treasury bond corresponding to the expected term of the option. Option forfeiture rates are based on the Company’s historical forfeiture rates. The Company has not paid dividends and does not expect to pay dividends in the near future.

All options issued during the nine months ended September 30, 2007 and 2006 were at or above the market price on the date of grant. The fair value of each option grant for the nine months ended September 30, 2007 and 2006 was estimated on the date of grant using the Black-Scholes Option Valuation Model with the following assumptions:

	Nine Months Ended
	September 30, 2007		September 30, 2006
Risk-free interest rate	4.00%-4.81	%	4.51%-5.19	%
Expected option life in years
Directors and officers	5.0	Years	6.0	years
Others	4.0	Years	4.5	years
Expected stock price volatility	50%-56	%	60%-65	%
Expected dividend yield	0.0	%	0.0	%

The Company recognized stock-based compensation pursuant to SFAS No. 123R of $783,000 ($668,000, or $0.04 per share and on a fully diluted basis, net of tax) and $776,000 ($665,000, or $0.04 per share and on a fully diluted basis, net of tax) for the three months ended September 30, 2007 and 2006, respectively, which was charged to selling, general and administrative expenses. The effect on income from recognizing stock-based compensation for the nine months ended September 30, 2007 and 2006 was $2,393,000 ($2,019,000, or $0.12 per share on a fully diluted basis, net of tax) and $2,625,000 ($2,308,000, or $0.14 per share on a fully diluted basis, net of tax), respectively, which was also charged to selling, general and administrative expenses.

Prior to the adoption of SFAS No. 123R, the Company presented cash flows resulting from the tax benefits of deductions from the exercise of stock options as operating cash flows in the Statement of Cash Flows. SFAS No. 123R requires cash flows resulting from the tax benefits from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The Company realized tax benefits from the exercise of stock options during the nine months ended September 30, 2007 and 2006 of $968,000 and $126,000, respectively.

Compensation costs for stock options with tiered vesting terms are recognized ratably over the vesting period. As of September 30, 2007 and 2006 the total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Plans was $4,439,000 and $6,144,000, respectively. These expenses are recognized over a weighted average period of 19 and 25 months, respectively, assuming no changes to the underlying assumptions. The total fair value of shares vested during the three months ended September 30, 2007 and 2006 was $74,000 and $190,000, respectively. The total fair value of shares vested during the nine months ended September 30, 2007 and 2006 was $523,000 and $723,000, respectively.

Unvested options as of September 30, 2007 and 2006, and changes in such options during the nine month periods then ended are summarized below:

	2007			2006
	Number of Options		Weighted- Average Grant Date Fair Value Per Share	Number of Options		Weighted- Average Grant Date Fair Value Per Share
Unvested Balance, January 1	711,290		$ 9.22	1,107,256		$ 9.58
Granted	188,550		9.24	86,700		6.66
Vested	(48,192	)	10.87	(56,505	)	12.79
Expired or forfeited	(145,640	)	8.09	(106,646	)	9.33

Unvested Balance, Sept. 30	706,008		$ 9.06	1,030,805		$ 9.25

Note N –Related Party Transactions

Transactions With Shareholders and Officers

The Company currently leases approximately 33,000 square feet of office space at 383 Route 46 West, Fairfield, New Jersey, under a lease expiring on January 31, 2013. The owner and manager of this property is a limited liability company (“LLC”) that is owned and controlled by the Glassman family. The purpose of the LLC is to own and manage the property at 383 Route 46 West. The lease agreement obligates the Company to pay 3% increases in annual lease payments per year. Rent expense, including the Company’s proportionate share of real estate taxes, was approximately $167,000 and $157,000 for the three months ended September 30, 2007 and 2006, respectively and $499,000 and $457,000 for the nine months ended September 30, 2007 and 2006, respectively. As of December 31, 2006, the assets of the LLC were approximately $1,600,000 and the estimated liabilities were $1,400,000. Daniel Glassman, the Company’s Chief Executive Officer and President, and Iris Glassman, a former officer and member of the Company’s Board of Directors and spouse of Daniel Glassman own 10% and their children, including Bradley Glassman, Senior Vice President Sales and Marketing of the Company, own 90% of this LLC.

Note O —Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial position, cash flows, and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”(“SFAS No. 157”). SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed

by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company has not yet determined the impact, if any, that the implementation of SFAS No. 157 will have on its results of operations or financial condition.

Note P —Commitments & Contingencies

1.Legal Proceedings

Contract Disputes

The Company and the licensor of one of the Company’s products currently disagree as to the interpretation of certain provisions in their license that relate to sales based milestones that may be payable by the Company. During the Fourth Quarter of 2006, the Company accrued $500,000 as a probable resolution of this contractual disagreement.

Shareholder Lawsuits

The Company, along with certain of its officers and directors, were named defendants in thirteen federal securities lawsuits that were consolidated on May 5, 2005 in the United States District Court of New Jersey. In the amended consolidated complaint, filed on June 20, 2005, the plaintiffs allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, arising out of disclosures that plaintiffs allege were materially false and misleading. Plaintiffs also allege that the Company and the individual defendants falsely recognized revenue. Plaintiffs sought an unspecified amount of compensatory damages in an amount to be proven at trial. The Company and the individual defendants filed its initial response on July 20, 2005 seeking to dismiss the amended consolidated complaint in its entirety with prejudice. On March 23, 2006, the Court issued an order denying the Company’s motion to dismiss the federal securities class action lawsuit. The Company continues to dispute the allegations set forth in the class action lawsuit and intends to vigorously defend itself. Pursuant to a June 28, 2006 Scheduling Conference with the Court and the Court’s Pretrial Scheduling Order of that date, discovery in the federal securities class action lawsuit has begun. Plaintiffs filed a motion for class certification on January 15, 2007. Defendants filed their response on April 2, 2007. On April 23, 2007, the court issued an order staying further deadlines in this matter pending the completion of mediation between the parties. The mediation was held on June 13, 2007, but a resolution has not been reached. On September 4, 2007, Plaintiffs withdrew their motion for class certification without prejudice to re-file the motion.

parties’agreement, these two related state shareholder derivative actions were consolidated on July 19, 2005 in the Superior Court of New Jersey. Plaintiffs in the state shareholder derivative actions filed a consolidated amended derivative complaint on May 12, 2006. The Company and the individual defendants filed its initial response on July 17, 2006 seeking to dismiss the alleged derivative complaint in its entirety with prejudice. On October 30, 2006, the court granted the defendants’ motion to dismiss and dismissed the derivative complaint with prejudice. Plaintiffs filed a notice of appeal on December 14, 2006 and their appeal papers on April 27, 2007. Briefing on the appeal was completed on June 21, 2007. Oral argument on the appeal was held on October 23, 2007. The Court has not yet ruled on the appeal.

Further, a federal shareholder derivative action was filed in the United States District Court of New Jersey against the Company and certain of its officers and directors. Service of process in this matter was accepted by the Company and the other defendants on April 26, 2006. After the Company and the other defendants filed on June 16, 2006 a motion to dismiss the derivative claim in this action, the shareholder filed an amended complaint on July 14, 2006 alleging a sole count for breach of fiduciary duties arising out of substantially the same allegations made in the federal securities class action lawsuit. The Company and the individual defendants have filed a motion to dismiss the alleged derivative complaint in its entirety with prejudice. Oral argument is scheduled for November 9, 2007.

Five complaints have been filed in connection with Daniel Glassman’s May 29, 2007 public announcement disclosing his intent to propose an acquisition of the Company’s outstanding shares. The complaints allege that the genesis and consideration of this proposal are breaches of the Board of Directors’ fiduciary dutiesand that the proposed transaction does not meet the entire fairness standard. The complaints seek, among other relief, to enjoin defendants from further breaching their fiduciary duties and from consummating the proposal. Four of those complaints are styled as class actions and were filed in the Law or Chancery divisions in New Jersey state court. The complaints were consolidated in the Law Division and have been adjourned pending a conference with the judge scheduled for December 14, 2007. The fifth complaint is styled as both a class and derivative action and was filed in the United States District Court of New Jersey. In the federal action, plaintiff has until December 14, 2007 to file an amended complaint and defendants have until January 18, 2008 to answer or otherwise respond to the amended complaint.

The Company expects to incur additional substantial defense costs regardless of the outcome of these lawsuits. Likewise, such events have caused, and will likely continue to cause, a diversion of the Company’s management’s time and attention.

SEC Inquiry

Company is cooperating with this inquiry, however, the Company is unable at this point to predict the final scope or outcome of the inquiry, and it is possible the inquiry could result in civil, injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions. The conduct of these proceedings could negatively impact the Company’s stock price. Since the Company cannot predict the outcome of this matter and its impact on the Company, the Company has made no provision relating to this matter in its financial statements. In addition, the Company expects to continue to incur expenses associated with the SEC inquiry and its repercussions, regardless of the outcome of the SEC inquiry, and the inquiry may divert the efforts and attention of the Company’s management team from normal business operations. During the Second Quarter 2006, the Audit Committee completed its previously announced internal review related to the SEC’s informal inquiry. The Audit Committee conducted its review with the assistance of independent counsel. The Audit Committee’s conclusions were delivered to the full Board of Directors, the SEC and the Company’s independent accountants.

General Litigation

The Company and its operating subsidiaries are parties to other routine actions and proceedings incidental to the Company’s business. There can be no assurance that an adverse determination on any such action or proceeding would not have a material adverse effect on the Company’s business, financial condition or results of operations. The Company discloses material amounts or ranges of reasonably possible losses in excess of recorded amounts.

The Company accounts for legal fees as services are incurred.

Note Q –Senior Credit Facility

On August 3, 2007, the Company entered into an amended and restated credit facility, or the New Facility, with a syndicate of lenders led by Wachovia Bank. The New Facility, which replaced the Facility (as defined below), provides for a $15,000,000 revolving line of credit that is secured by a lien upon substantially all of the Company’s assets, including those of its subsidiaries, and is guaranteed by the Company’s domestic subsidiaries. At September 30, 2007, the Company has $1,125,000 in deferred financing costs, net of accumulated amortization, on its consolidated balance sheet related to the New Facility. These costs are being amortized in interest expense over the length of the agreement. The Company currently has no outstanding debt under the New Facility.

Amounts outstanding under the New Facility will accrue interest at the Company’s choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus an applicable percentage ranging from .75% to 1.25% based on the Company’s leverage ratio, as defined in the amended and restated credit agreement or (ii) a rate equal to the sum of the applicable LIBOR rate plus an applicable percentage ranging from 1.75% to 2.25% based on the Company’s leverage ratio, as defined in the amended and restated credit agreement. In addition, the lenders under the New Facility are entitled to

customary facility fees based on unused commitments under the New Facility and outstanding letters of credit.

The financial covenants under the New Facility require that the Company maintain (i) a leverage ratio (which is a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) an interest coverage ratio (which is a ratio of consolidated EBITDA to consolidated interest expense) greater than or equal to 3.00 to 1.00; and (iii) consolidated capital expenditures at less than or equal to $5,000,000 during each fiscal year and all consolidated capital expenditures made during the term of the amended and restated credit agreement at less than $12,500,000. The New Facility also limits the Company’s ability to declare and pay cash dividends. As of September 30, 2007, the Company is in compliance with the covenants under the New Facility.

Prior to August 3, 2007, the Company operated under a $110,000,000 credit facility, or the old Facility, with a syndicate of lenders also led by Wachovia Bank, which had been amended from time to time. The old Facility was comprised of an $80,000,000 term loan and a $30,000,000 revolving line of credit secured by a lien upon substantially all of the Company’s assets, including those of its subsidiaries, and was guaranteed by the Company’s domestic subsidiaries.

Amounts outstanding under the old Facility accrued interest at the Company’s choice from time to time of either (i) the alternate base rate (which was equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus 3%; or (ii) a rate equal to the sum of the applicable LIBOR rate plus 4%. In addition, the lenders under the old Facility were entitled to customary facility fees based on unused commitments and outstanding letters of credit.

The financial covenants under the old Facility required that the Company maintain (i) a leverage ratio (which was a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) a fixed charge coverage ratio (which was a ratio of (A) consolidated EBITDA, minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00; and (iii) not less than $25,000,000 of unrestricted cash and cash equivalents on its balance sheet at all times. Further, the old Facility limited the Company’s ability to declare and pay cash dividends.

On August 3, 2007, concurrently with the closing of the New Facility, the Company repaid the outstanding principalbalance of $62,370,000 under the old Facility. The Board determined that the repayment was an appropriate use of the Company’s existing cash and cash equivalents based on the Board’s desire, among other things, to reduce the Company’s interest expense. In addition, the Company wrote-off $3,256,000 in deferred financing costs in the Third Quarter of 2007 related to the payment of the outstanding balance under the old Facility.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes included elsewhere in this Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2006. The following discussion and analysis contains forward-looking statements regarding our future performance and business strategy. All forward-looking information is inherently uncertain and actual results may differ materially from the assumptions, estimates or expectations reflected or contained in the forward-looking statements. See “Forward-Looking Statements” and “Risk Factors” included in our Form 10-K for the year ended December 31, 2006 and elsewhere in this Form 10-Q.

Forward-Looking Statements

Some of the statements under the captions “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006 or in this Form 10-Q under Part II, Item 1A, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or otherwise contained in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, including:

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our plans to in-license, develop and launch new and enhanced products with long-term intellectual property protection or other significant barriers to market entry, such as VEREGEN™;

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our ability to maintain or increase sales;

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our ability to launch VEREGEN™ at the end of 2007;

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completion of the proposed merger transaction with Nycomed US Inc. on a timely basis, if at all;

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our ability to compete in the marketplace against generic or therapeutically equivalent products;

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our ability to estimate for charges against sales, including returns, chargebacks and rebates;

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our ability to continue to develop products internally with longer lifecycles and to extend indications for our current product portfolio;

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our ability to secure regulatory consents and approvals, if necessary, for new products;

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our ability to expand existing partnerships and joint venture relationships with biotechnology companies and foster new strategic alliances designed to deliver a stronger product portfolio;

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our reliance on third party manufacturers and suppliers;

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our ability to react to changes in governmental regulations affecting products we market;

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our estimates of future financial condition and results of operations;

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our ability to favorably resolve the SEC’s informal inquiry;

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the possibility that a group of investors led by Daniel Glassman, founder, director, President and CEO of the Company and the holder of nearly all of the Company’s Class B common stock, may make a bid to acquire all of the outstanding shares of Bradley common stock and Class B common stock at a price greater than $20.00 per share;

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our ability to complete the returns and inventory optimization plan timely;

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our ability to favorably resolve state and federal shareholder derivative and federal securities class action lawsuits;

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our ability to maintain adequate inventory levels;

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our ability to satisfy the covenants contained in our new senior credit facility;

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our ability to obtain new distributors and market approvals in new countries;

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our ability to access the capital markets on attractive terms or at all;

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our ability to achieve our initiatives to enhance corporate governance and long-term stockholder value;

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our ability to reduce product returns; and

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the impact of the changes in the accounting rules discussed in this Form 10-Q.

In some cases, you can also identify forward-looking statements by terminology such as “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar expressions. All forward-looking statements are based on assumptions that we have made based on our experience and perception of historical trends, perception of current conditions, expected future developments and other factors we believe are appropriate under the circumstances. These statements are subject to numerous risks and uncertainties, many of which are beyond our control, including the statements set forth

under “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2006 and in Item 1A of Part II of this Form 10-Q.

No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. Except as required by law, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

Proposed Merger with Nycomed US Inc.

The Company and Nycomed US have made customary representations, warranties and covenants in the Merger Agreement, including, among others: (i) covenants generally requiring us to conduct our business prior to the closing of the Merger in the ordinary course consistent with past practice; (ii) subject to our Board of Directors’ right to exercise its fiduciary duties, covenants restricting the solicitation of competing acquisition proposals, and (iii) covenants relating to obtaining the required approval of our stockholders. The transaction is conditioned on receipt of approval by holders of a majority of the outstanding shares of our common stock and Class B common stock, voting together as one class. The transaction is also subject to the expiration or termination of applicable waiting periods under United States and foreign anti-trust laws and other customary closing conditions. There is no financing condition, and the obligations of Nycomed US are guaranteed by Nycomed S.C.A., SICAR. The terms of the Merger Agreement include provisions prohibiting us from soliciting an alternate takeover proposal from a third party, or entering into negotiations or discussions regarding an alternate proposal unless such proposal is deemed to be a “Superior Proposal” (as defined in the Merger Agreement) by our Board of Directors by a vote of a majority of the disinterested Directors. It also includes a termination fee equal to 3% of the Merger Consideration (as defined in the Merger Agreement) to be paid by us to Nycomed US if the Merger Agreement is terminated under specified circumstances. This description of certain terms of the Merger Agreement and the Guaranty of Nycomed S.C.A., SICAR and the transactions contemplated by the Merger Agreement and such Guaranty is qualified in its entirety by reference to the full text of the Merger Agreement and the Guaranty, copies of which were filed as exhibits to our Current Report on Form 8-K filed on October 30, 2007.

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is intended to help the reader understand our historical results and anticipated outlook prior to the close of the proposed merger. The transaction is expected to be completed in the first quarter of 2008 although we cannot assure you that it will close. For more information about the proposed transaction, refer to our Current Report on Form 8-K filed on October 30, 2007. We intend to file a proxy statement with the SEC that, when final, will contain details for a meeting of our stockholders to enable our stockholders to vote to adopt the Merger Agreement. The proxy statement will be sent to all our stockholders and will contain important information about us, the merger, risks relating to the merger and related matters. We strongly encourage our stockholders to read this proxy statement when available.

Overview

We are a specialty pharmaceutical company that acquires, develops and markets prescription and over-the-counter products in niche therapeutic markets, including dermatology, podiatry, gastroenterology and women’s health. Our business strategy contemplates our:

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in-licensing phase II and phase III drugs and developing and bringing to market products with long-term intellectual property protection or other significant barriers to market entry;

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commercializing brands that fill unmet patient and physician needs;

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expanding existing partnerships and joint venture relationships with biotechnology and specialty pharmaceutical companies and fostering new strategic alliances designed to deliver a stronger product portfolio; and

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increasing our focus on research and development activities to continue to develop products organically with longer lifecycles and to extend indications for our current product portfolio.

We have two primary business segments, Doak Dermatologics, specializing in therapies for dermatology and podiatry, and Kenwood Therapeutics, providing gastroenterology, women’s health, respiratory and other internal medicine brands. To a lesser extent, Kenwood Therapeutics also markets nutritional supplements and respiratory products. At October 31, 2007, Doak Dermatologics had a dedicated sales force of 129 professional sales representatives, while Kenwood Therapeutics had a dedicated sales force of 63 professional sales representatives. We also launched our A. Aarons subsidiary in 2006, which is focused on marketing authorized generic versions of Doak’s and Kenwood’s products, in an effort to maintain market share when our products encounter generic competition.

Following our business strategy of in-licensing and bringing to market products with long-term intellectual property protection or other significant barriers to market entry and bringing to market brands that fill unmet patient needs, the Company launched ELESTRIN™ (estradiol gel 0.06%) through its Kenwood Therapeutics Division in June 2007. ELESTRIN™ is an effective, low dose transdermal estrogen therapy that was approved by the FDA in December 2006 for the treatment of moderate-to-severe vasomotor symptoms associated with menopause. Bradley in-licensed the product from BioSante Pharmaceuticals late in 2006 and has exclusive marketing rights for ELESTRIN™ in the United States. ELESTRIN™ is patent protected until 2022 (additional pending patent applications may extend the patent life) giving the product significant intellectual property protection.

As part of this strategy, the Company also entered into an agreement in 2006 with MediGene AG (“MediGene”) to commercialize VEREGEN™, a new drug indicated for the treatment of external genital and perianal warts. VEREGEN™ is patented through 2017 (additional pending patent applications may extend the patent life) giving the product significant intellectual property protection. We currently expect to launch VEREGEN™ at the end of 2007. VEREGEN™ will be promoted to physicians by both our Doak Dermatologics and Kenwood Therapeutics sales forces. Our plan to grow net sales and profitability in the future would be adversely affected if, for any reason, we were unable to launch VEREGEN™ on a timely basis.

In order to support the ELESTRIN™ launch and, later in the year, the VEREGEN™ launch, the Company increased Kenwood’s sales force from 47 representatives at February 28, 2007 to 63 representatives at October 31, 2007 and will incur a corresponding amount of additional sales, marketing and related expenses in subsequent periods. Net sales of ELESTRIN™ are $678,000 through September 30, 2007, consisting primarily of launch quantities from June 2007. ELESTRIN™ sales have been slower than originally anticipated due to the use of trade packaging as samples, filling part of the initial prescription demand, and the Company’s process of building relationships with physicians in the women’s health market. According to its prescription data reported by Wolters Kluwer, the Company has experienced an increase in weekly

prescriptions for ELESTRIN™ in October 2007 and, although there can be no assurance, expects that sales of the product will begin to increase in subsequent quarters.

Our business strategy also focuses on developing products internally with longer lifecycles and extending indications for our current product portfolio. In executing this strategy we launched ADOXA^® 150mg capsules in July 2007 and three new line extensions, PERANEX™ HC CREAM, KEROL™ TOPICAL SUSPENSION and ROSULA^® CLARIFYING WASH™, late in the Second Quarter of 2007. PERANEX™ HC CREAM, marketed by the Company’s Kenwood Therapeutics division, is the first product in a new line of anorectal treatments used for the anti-inflammatory and anesthetic relief of itching, pain, soreness and discomfort due to hemorrhoids, anal fissures, pruritus ani and similar conditions of the anal area. KEROL™ TOPICAL SUSPENSION (50% Urea), marketed by Doak Dermatologics, is an addition to the line of KEROL™ REDI-CLOTHS keratolytic moisturizers and is indicated for the treatment of hyperkeratotic conditions such as dry, rough skin, dermatitis, psoriasis, xerosis, ichthyosis, eczema, keratosis pilaris, keratosis palmaris, keratoderma, corns and calluses. ROSULA^® CLARIFYING WASH™ (sodium sulfacetamide 10% and sulfur 4%) is the fourth product launched under the ROSULA^® brand and is indicated for the treatment of acne vulgaris, acne rosacea and seborrrheic dermatitis. Although there can be no assurance, the Company expects revenues from these products, with the exception of PERANEX™ HC CREAM which based on the Company’s market intelligence is expected to have generic competition in the Fourth Quarter of 2007, to increase in future periods.

In June 2007, the Company launched its authorized generic version for ADOXA^®150mg doxycycline monohydrate tablets through a licensing and distribution agreement with Par Pharmaceutical Companies, Inc. (“Par”) in response to generic competition. Par began immediate shipments of the product and will split the profits from its sales with the Company pursuant to the agreement. The Company expects that its sales of ADOXA^® 150mg tablets, which represented approximately 19% of our 2006 net sales, will continue to be significantly reduced in subsequent quarters and will not be fully offset by revenues from Par’s sales of ADOXA^® 150mg tablets and Bradley’s sales of ADOXA^® 150mg capsules.

In April 2007, the Company implemented an inventory optimization plan designed to reduce future returns by decreasing customer inventory in the channel and to ship products with increased shelf-life to wholesalers by optimizing product production planning, which is described under“Critical Accounting Policies”. The Company believes the increase in gross prescription sales in the Third Quarter of 2007 compared to the Second Quarter of 2007 indicates a greater portion of the current demand is being satisfied through current quarter sales rather than inventory in the channel and that the implementation of the plan contributed to lower gross prescription sales in the Second Quarter of 2007 compared to those in previous quarters. As outlined in the table below, gross prescription demand outpaced sales in the most recent quarters, indicating a portion of the demand, particularly in the Second Quarter of 2007, was satisfied by inventory in the channel rather than through new sales. Pursuant to the returns and inventory optimization plan the Company estimates it had reduced inventory of all products in the

distribution channel from $36,400,000 at December 31, 2006 to $33,243,000 at March 31, 2007 and to $27,432,000 at June 30, 2007. Although months of inventory on hand for the primary wholesale customers continued to decrease at September 30, 2007, the dollar value of inventory of all products in the distribution channel increased from the Second Quarter of 2007 to $29,331,000 primarily due to sales of DECONAMINE^® in the Third Quarter of 2007, which the Company previously had on backorder due to an inability to secure active ingredient. DECONAMINE^®inventory in the channel was $2,298,000 at September 30, 2007 compared to $61,000 at June 30, 2007. The following table is a comparison of the gross prescription demand, gross prescription sales, our returns provision and net sales for the last seven quarters.

	Q106	Q206	Q306	Q406
Gross prescription demand (1)	$46,873,000	$46,705,000	$47,878,000	$50,353,000
Gross prescription sales (2)	$45,000,000	$44,000,000	$45,000,000	$48,000,000
Returns provision (3)	$ 8,639,000	$ 8,027,000	$ 5,996,000	$ 8,719,000
Net sales (3)	$34,753,000	$37,150,000	$35,204,000	$37,699,000

	Q107	Q207	Q307
Gross prescription demand (1)	$54,761,000	$53,238,000	$50,717,000
Gross prescription sales (2)	$44,811,000	$36,535,000	$44,351,000
Returns provision (3)	$ 6,918,000	$ 2,550,000	$ 7,202,000
Net sales (3)	$37,803,000	$32,159,000	$33,553,000

(1) As reported by Wolters Kluwer, a third party provider of prescription data. Wolters Kluwer’s projected gross prescription demand is calculated based upon estimated retail sales value.

(2) The Company’s actual results. Gross prescription sales are based upon actual gross prescription sales at current gross selling prices and do not include charges for discounts, returns, chargebacks and rebates and do not include sales of the Company’s over-the-counter products.

(3) The Company’s actual results. Net sales include sales of both prescription and over-the-counter products and include charges for discounts, returns, chargebacks and rebates.

We derive a majority of our net sales from our core branded products: ADOXA®, ANAMANTLE®HC, ELESTRIN™, FLORA-Q®, KERALAC®/KEROL™, LIDAMANTLE®, PAMINE®, ROSULA®, SOLARAZE® and ZODERM®. These core branded products accounted for a total of approximately 80% and 87% of our net sales for the nine months ended September 30, 2007 and for fiscal year 2006, respectively. Of these core products, only SOLARAZE®, KEROL™, FLORA-Q® and ELESTRIN™ currently do not face some sort of pricing competition from generic or therapeutically equivalent products.

With the exception of SOLARAZE® and ELESTRIN™, which are patented through at least 2014 and 2022, respectively, and potential products expected to be launched in the future including VEREGEN™, which is patented through at least 2017, there is no meaningful intellectual property or proprietary protection for our other material branded pharmaceutical products, including ADOXA®, and competing generic or therapeutically equivalent versions for most of these other products are sold by other pharmaceutical companies. In addition, governmental and other pressure to reduce pharmaceutical costs may result in physicians prescribing products for which there are generic or therapeutically equivalent products. Since 2004, our net sales have been negatively impacted by the onset and increase in generic or therapeutically equivalent products competing on price with our brands. Increased competition from the sale of generic or therapeutically equivalent

products may cause a further decrease in sales that would have an adverse effect on our business, financial condition and results of operations. As a result of increased generic competition, the execution of Distribution Service Agreements (DSAs) with three of our wholesale customers, two of whom are our two largest customers, and a change in these customers’ market dynamics, we have also experienced an increase in product returns. Our branded products for which there are no generic or therapeutically equivalent forms may also face competition from different therapeutic treatments used for the same indications for which our branded products are used.

Critical Accounting Policies

In preparing financial statements in conformity with accounting principles generally accepted in the United States, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the relevant reporting period. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant estimates used in the preparation of financial statements. Management has discussed the development and selection of the critical accounting estimates discussed below with our audit committee, and our audit committee has reviewed our disclosures relating to these estimates.

Revenue recognition. Revenue from product sales, net of estimated provisions, is recognized when the merchandise is shipped to and/or received by an unrelated third party, as provided in SAB No. 104, “Revenue Recognition in Financial Statements.” Accordingly, revenue is recognized when all four of the following criteria are met:

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persuasive evidence that an arrangement exists;

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delivery of the products has occurred;

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the selling price is both fixed and determinable;

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collectability is reasonably probable.

Our customers consist primarily of large pharmaceutical wholesalers who sell directly into the retail channel. Provisions for returns, rebates, chargebacks and discounts are established as a reduction of product sales revenues at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves. These revenue reductions are generally reflected either as a direct reduction to accounts receivable through an allowance or as an addition to accrued expenses.

Other than A. Aarons’ sales, we do not provide any forms of price protection to wholesale customers other than a contractual right to three wholesale customers (who together accounted for 71% of our gross sales in the first nine months of 2007) that our price increases and product purchase discounts offered during a specified twelve-month

period will allow for inventory of our products then held by these wholesalers to appreciate in the aggregate. We do not, however, guarantee that our wholesale customers will sell our products at a profit.

Allowances for returns. In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used by its expiration date, which is typically two to three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date to up to twelve months after the expiration date. Our return policy conforms to industry standard practices. Management is required to estimate the level of sales that will ultimately be returned pursuant to our return policy and to record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net sales. We believe that we have sufficient data to estimate future returns at the time of sale. Management periodically reviews the allowances for returns and adjusts them based on actual experience. If we over or under estimate the level of sales that will ultimately be returned, there may be a material impact to our financial statements.

The Company has DSAs with three of its customers Cardinal Health, Inc., McKesson Corporation and Kinray, Inc. Under the terms of each of these DSAs, we have agreed to pay, under certain circumstances, a fee in exchange for certain product distribution, inventory management, and administrative services. The terms of our DSAs are consistent with the industry’s movement toward fee-for-service. These agreements have, among other things, improved our knowledge of demand for our products, reduced the level of wholesale inventories of our products and improved channel transparency as the wholesalers provide us with periodic reports of inventory and demand levels of our products under the terms of the DSAs. Subsequent to entering the DSAs, we only offer customary new product launch incentives.

Prior to entering our first DSA in the First Quarter of 2005, we followed the industry practice of offering customers pricing incentives to ensure that supplies in the distribution channel would be sufficient to avoid lack of stock. Although these promotions caused wholesaler buying spikes, we believe the channel was not inflated. Based upon our review of the wholesaler inventory that is available to us, we believe the level of product in the channel at September 30, 2007 is approximately 1.3 months for the primary wholesale customers and 0.9 months for all other locations compared to 1.7 and 0.9 months, respectively, at December 31, 2006.

When we launch new products we disclose those sales under “Results of Operations.” We record our incentive sales in the period in which the related products are shipped or delivered, net of applicable allowances.

At September 30, 2007 our return reserve was $22,497,000. In order to reasonably estimate future returns, we analyze both quantitative and qualitative information including, but not limited to, actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and general economic and industry wide indicators. Certain specifics regarding these analyses are as follows:

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Actual return rates- We track actual returns by product. We determine the provision for our current sales using actual return rates. Our actual returns by therapeutic category for the three and nine months ended September 30, 2007 and 2006 are detailed in the table below.

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Level of product in the distribution channel- We analyze and utilize wholesale inventory reports provided to us by our largest wholesale customers. In particular, the wholesale inventory reports provide us the current wholesaler demand by product and actual product inventory held by the same wholesaler. We also estimate the level of product in the distribution channel held by small wholesale customers and retail chains that do not provide us inventory reports based upon discussions with them and our actual sales to these locations. The estimate for the non-reporting locations is based upon verbal communications we have had with some of our retail chain customers. Based upon gathering the information of the non-reporting inventory locations, we estimate the additional weeks of product at these locations. If our estimate for the non-reporting locations, a component of our allowance for returns, were different by one week of demand, our return reserve at September 30, 2007 would increase or decrease by approximately $1,592,000. We believe a difference of one week of demand for the non-reporting locations is not reasonably likely but is possible due to the subjective nature of this estimate.

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We also estimate product returns in-transit that are not included in the wholesale inventory reports and not received by us for processing based upon discussions we have with our return processor and our customers. For the September 30, 2007 allowance for returns, we used actual subsequent returns and estimated the

time between when the customer removes our product from their inventory and the time we record the return credit. If our estimate for product returns in-transit, based upon actual subsequent returns, is different by one week, our return reserve at September 30, 2007 would increase or decrease by approximately $358,000. We believe a difference of one week for the returns in-transit is not reasonably likely but is possible due to the subjective nature of this estimate. The estimate for the returns in-transit is based upon verbal communications we have had with some of our larger wholesale customers, wholesale customers’ return processing centers and our outsourced return processing center. The level of product in the distribution channel is used to determine the maximum return exposure and is compared against the product return reserve created by utilizing the actual return rate trends. The estimated return value at September 30, 2007 of all our products in the distribution channel was approximately $29,331,000 compared to $27,432,000 at June 30, 2007, $33,243,000 at March 31, 2007 and $36,400,000 at December 31, 2006. Although months of inventory on hand for the primary wholesale customers continued to decrease at September 30, 2007, the dollar value of inventory of all products in the distribution channel increased primarily due to sales of DECONAMINE® in the Third Quarter of 2007, which the Company previously had on backorder due to an inability to secure active ingredient. DECONAMINE® inventory in the channel was $2,298,000 at September 30, 2007 compared to $61,000 at June 30, 2007. Our estimated return value of all our products in the distribution channel and our related allowance for returns at September 30, 2007 by therapeutic categories is presented in the table below.

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Estimated shelf life- We track our returns by lot numbers and compare the lot numbers to when a range of sales may have occurred to determine an estimated average shelf life. We use this historical average as part of our overall process of estimating future returns.

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Current and projected demand- We utilize prescription demand data provided by Wolters Kluwer, an industry standard third party source, and wholesale inventory reports provided by our wholesale customers.

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Competitive or generic products that may erode current demand- For competitive product launches, including generics, we utilize our historical experience of competitive product/ generic intrusion to estimate our return reserve allowance.

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New product launches- For our new product launches, we utilize our historical experience of new product sales in comparison to the same new product returns to estimate our return reserve allowance.

Our actual returns by therapeutic category for the three and nine months ended September 30, 2007 and 2006 are as follows:

					*Range of Expiration Periods (in years) Sept. 30, 2007
	Three months ended		Nine months ended
Therapeutic Category by Company	September 30, 2007	September 30, 2006	September 30, 2007	September 30, 2006
Doak Dermatologics, Inc.
Keratolytic	$1,009,000	$1,423,000	$ 2,911,000	$ 5,980,000	2
Acne/Rosacea	4,465,000	2,982,000	12,407,000	7,811,000	1.5 - 2
Actinic Keratoses	228,000	310,000	695,000	1,374,000	2 - 2.5
Anesthetics	698,000	461,000	1,424,000	2,145,000	2 - 3
Scalp	69,000	340,000	407,000	591,000	2
Cosmeceuticals/ Other	101,000	18,000	196,000	100,000	2-3

Total	$6,570,000	$5,534,000	$18,040,000	$18,001,000

Kenwood Therapeutics
Gastrointestinal	$ 664,000	$1,384,000	$ 1,953,000	$ 2,836,000	2
Respiratory	220,000	588,000	449,000	1,110,000	2 - 5
Nutritional	26,000	33,000	79,000	135,000	2 - 3

Total	$ 910,000	$2,005,000	$ 2,481,000	$ 4,081,000

TOTAL	$7,480,000	$7,539,000	$20,521,000	$22,082,000

* Based upon date of manufacture to labeled expiration date.

Our actual return credits issued to our customers for the three and nine months ended September 30, 2007 and 2006 are as follows:

	Three months ended		Nine months ended
Customer	September 30, 2007	September 30, 2006	September 30, 2007	September 30, 2006
AmerisourceBergen Corp.	$ 513,000	$ 420,000	$ 1,479,000	$ 1,537,000
Cardinal Health, Inc.	3,252,000	2,076,000	8,847,000	9,230,000
McKesson Corporation	3,465,000	2,550,000	9,483,000	8,274,000
Quality King	—	2,299,000	6,000	2,303,000
Kinray	36,000	38,000	116,000	107,000
Others	214,000	156,000	590,000	631,000

TOTAL	$7,480,000	$7,539,000	$20,521,000	$22,082,000

Our estimate of all our products in the distribution channel at an estimated return value and our related allowance for returns at September 30, 2007 and December 31, 2006 by therapeutic categories is as follows:

September 30, 2007
Therapeutic Category by Company	Estimated Product in the Distribution Channel	Allowance for Returns	% of Total
Doak Dermatologics, Inc.
Keratolytic	$ 4,285,000	$ 3,557,000	83	%
Acne/Rosacea	12,224,000	9,444,000	77	%
Actinic Keratoses	3,663,000	2,998,000	82	%
Anesthetics	1,735,000	1,585,000	91	%
Scalp	167,000	162,000	97	%
Cosmeceuticals/Other	261,000	201,000	77	%

Total	$22,335,000	$17,947,000	80	%

Kenwood Therapeutics
Gastrointestinal	$ 3,525,000	$ 2,947,000	84	%
Respiratory	2,590,000	1,373,000	53	%
Nutritional/Other	881,000	230,000	26	%

Total	$ 6,996,000	$ 4,550,000	65	%

TOTAL	$29,331,000	$22,497,000	77	%

December 31, 2006
Therapeutic Category by Company	Estimated Product in the Distribution Channel	Allowance for Returns	% of Total
Doak Dermatologics, Inc.
Keratolytic	$ 5,459,000	$ 4,537,000	83	%
Acne/Rosacea	17,317,000	11,956,000	69	%
Actinic Keratoses	3,584,000	2,682,000	75	%
Anesthetics	2,065,000	1,071,000	52	%
Scalp	551,000	484,000	88	%
Cosmeceuticals/Other	183,000	163,000	89	%

Total	$29,159,000	$20,893,000	72	%

Kenwood Therapeutics
Gastrointestinal	$ 6,064,000	$ 4,414,000	73	%
Respiratory	880,000	833,000	95	%
Nutritional/Other	303,000	208,000	69	%

Total	$ 7,247,000	$ 5,455,000	75	%

TOTAL	$36,406,000	$26,348,000	72	%

Without utilizing assumptions, we cannot currently specify when actual returns relate to a current period or prior period due to the nature of the sales process. Therefore, we use a number of assumptions when calculating our reserve estimates based upon the following circumstances. We primarily sell our products to wholesalers. The wholesalers maintain inventory of products consistent with their industry practices and perceived business interests. The wholesalers resell their inventory of products to pharmacies, which may also maintain an inventory of product. Thus, the date on which we sell the product to the wholesaler may be different from the date of sale to the end-user. We produce our product in quantity “lots” that we believe best optimize our purchasing power in light of estimated demand. We retain lot information on product delivered to our customers. Each lot produced fills a number of customer orders, often spanning a number of months that may not coincide with our financial reporting periods. When our customers return product, they do not usually specify the original sales date, but we can see and track the respective product lots. We make assumptions in filling orders at the wholesalers. We know the quantity sold from each lot and apply this historical lot information on product sales to determine future potential returns. We also apply third party prescription data and information from our largest wholesalers and we make adjustments for estimated product in the return channels in order to provide consistent cut-off periods with the reports received from our largest wholesalers. Using this information, we estimate returns on a quarterly basis.

Our roll-forward of the allowances for returns is included in “Results of Operations.”

The estimated product in the distribution channel for the Company’s two largest wholesalers, Cardinal and McKesson, in the aggregate at September 30, 2007 was $12,626,000 compared to $12,247,000 at June 30, 2007, $16,942,000 at March 31, 2007 and $20,512,000 at December 31, 2006. The estimated product in the distribution channel (including returns in transit) for AmerisourceBergen, which only reported inventory to us at September 30, 2007, and other non-reporting wholesalers and retailers was $16,705,000 at September 30, 2007 compared to $15,185,000 at June 30, 2007, $16,300,000 at March 31, 2007 and $15,895,000 at December 31, 2006.

In April 2007, we adopted a returns and inventory optimization plan in an attempt to reduce future returns. The plan of action included the following:

•

Reducing wholesaler inventory to five weeks by September 30, 2007 and four weeks by December 31, 2007. At September 30, 2007, the Company had reduced its inventory in the channel to approximately five and one half weeks. In addition, wholesaler inventory levels for products that had a greater risk of encountering generic competition, including ADOXA^® 150mg tablets, were approximately four weeks at September 30, 2007.

•

Implementing revised minimum shelf-life shipping requirements. The current plan is to ship up to 10 months prior to expiration for product that is manufactured with 18 month expiration dates, 12 to 15 months prior to expiration for product that is manufactured with 24 month expiration dates and 18 months prior to

expiration for product that is manufactured with 30 to 60 months expiration dates. Implementation of this plan, in addition to generic competition on certain products, particularly ADOXA® 150mg tablets, contributed to higher inventory reserves at September 30, 2007. Inventory write-offs were approximately $1,116,000 and $3,523,000, respectively, during the three and nine months ended September 30, 2007 compared to $656,000 and $1,087,000, respectively, during the corresponding periods of 2006.

•

Optimizing product production planning to increase effective dating on manufactured products. We are conducting a cost/benefit analysis of our product production schedules in order to analyze the potential benefit of producing small size batches.

The actions described above are an attempt to lower our future returns. Our returns provision as a percentage of gross sales was 16% and 12%, respectively, for the three and nine months ended September 30, 2007 compared to 12% and 16% in the corresponding periods of 2006. Although the percentage increased for the three months ended September 30, 2007 compared to the same period a year ago, the Company believes its focus on decreasing inventory in the channel pursuant to its returns and inventory optimization plan has contributed to the lower percentage for the whole year. We cannot, however, provide assurance that these trends will continue, or that our actions will be successful in reducing future product returns or that they will not result in an increase in the Company’s out-of- stock position on any of our products.

Allowances for rebates. At September 30, 2007, our rebate reserve was $4,668,000. Our contracts with Medicaid, other government agencies and managed care organizations commit us to providing those organizations with favorable pricing. This ensures that our products remain eligible for purchase or reimbursement under these programs. Based upon our contracts and the most recent experience with respect to sales through each of these channels and the amount of product in the distribution channel net of the return reserve, we provide an allowance for rebates. We monitor the rebate trends and adjust the rebate accrual to reflect the most recent rebate experience. If our estimate for the amount of product in the distribution channel net of the return reserve were different by one week of demand, our rebate reserve at September 30, 2007 would increase or decrease by approximately $257,000.

Without utilizing assumptions, we cannot currently specify when actual credits relating to rebates relate to a current period or prior period. The requests for rebates do not provide the product lot number, which is our only method of relating product sales to a specific time period. For rebates, we apply specific percentages based on trailing historical experience.

Our roll-forward of the allowances for rebates for the three and nine months ended September 30, 2007 and 2006 are as follows:

	Three Months Ended
	2007		2006
Allowance at July 1*,	$4,420,000		$3,435,000
Rebates processed in current period
relating to sales made in prior period	(3,188,000	)	(3,901,000	)
Current provision for rebates relating
to sales made in current period	3,436,000		3,794,000

Allowance at September 30*,	$4,668,000		$3,328,000

	Nine Months Ended
	2007		2006
Allowance at January 1*,	$3,087,000		$5,032,000
Rebates processed in current period
relating to sales made in prior period	(2,651,000	)	(3,529,000	)
Rebates processed in current period relating
to sales made in current period	(5,034,000	)	(4,739,000	)
Current provision for rebates relating to
sales made in current period	9,266,000		6,564,000

Allowance at September 30*,	$4,668,000		$3,328,000

* Shown within accrued expenses.

Allowances for Chargebacks. At September 30, 2007 our chargeback reserve was $125,000. Chargebacks are based on the difference between the prices at which we sell our products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payers, who are often governmental agencies. Based upon our contracts and the most recent experience with respect to sales through this channel and the amount of product in the distribution channel net of the return reserve, we provide an allowance for chargebacks. We monitor the chargeback trends and adjust the chargeback accrual to reflect the most recent chargeback experience. If our estimate for the amount of product in the distribution channel net of the return reserve were different by one week of demand, our chargeback reserve at September 30, 2007 would increase or decrease by approximately $55,000.

Without utilizing assumptions, we cannot currently specify when actual credits relating to chargebacks relate to a current period or prior period. The requests for chargebacks do not provide the product lot number, which is our only method of relating product sales to a specific time period. For chargebacks, we apply a specific percentage based on the trailing historical experience.

Our roll-forward of the allowances for chargebacks for the three and nine months ended September 30, 2007 and 2006 are as follows:

	Three Months Ended
	2007		2006
Allowance at July 1,*	$ 90,000		$ 100,000
Chargebacks processed in current period relating
to sales made in prior period (a)	(181,000	)	(191,000	)
Chargebacks processed in current period relating
to sales made in current period (a)	(652,000	)	(482,000	)
Current provision for chargebacks relating to
sales made in current period	868,000		681,000

Allowance at September 30,*	$ 125,000		$ 108,000

	Nine Months Ended
	2007		2006
Allowance at January 1,*	$ 135,000		$ 135,000
Chargebacks processed in current period relating
to ales made in prior period (a)	(236,000	)	(193,000	)
Chargebacks processed in current period relating
to sales made in current period (a)	(1,991,000	)	(1,720,000	)
Current provision for chargebacks relating to
sales made in current period	2,217,000		1,886,000

Allowance at September 30,*	$ 125,000		$ 108,000

Shown within accounts receivable.

(a)

Based upon receipt date of chargeback and the estimated level of inventory in the distribution channel.

Goodwill and Intangible assets. We have made acquisitions of products and businesses that include goodwill, license agreements, product rights and other identifiable intangible assets. We determine the estimated fair values of goodwill and certain intangible assets with definitive lives based on valuations performed by us at the time of acquisition in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). In addition, the fair value of certain amounts paid to third parties relating to product acquisitions or license agreements are recorded as intangible assets when we determine that technical feasibility for the acquired or licensed product has been established, which, for us, historically has been after the FDA has approved the product for commercialization.

Under SFAS No. 142, which eliminated the amortization of purchased goodwill, goodwill is tested for impairment at least annually and more frequently if an event occurs that indicates the goodwill may be impaired. We performed the test at December 31, 2006 and noted that no impairment existed.

Our intangible assets with definitive lives, also tested periodically for impairment, are capitalized and amortized over their estimated useful lives. The Company evaluates long-lived assets, including intangible assets with definitive lives, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). SFAS No. 144 states that an impairment loss shall be recognized only if the carrying amount of a long-lived asset is no longer recoverable.

We assess the impairment of identifiable intangibles, including goodwill, when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include:

•

significant underperformance compared to expected historical or projected future operating results;

•

significant changes in our use of the acquired assets or the strategy for our overall business; and

•

significant negative industry or economic trends.

When we determine that the carrying value of intangible assets may not be recoverable based upon the existence of one or more of these factors, we first perform an assessment of the asset’s recoverability based on expected undiscounted future net cash flow, and if the amount is less than the asset’s value, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. If the estimated undiscounted future cash flows from the use of an asset were less than the carrying value, a write-down would be recorded to reduce the related asset to its estimated fair value.

Determining the fair value of intangible assets and estimating useful lives is inherently uncertain and subject to significant risks and uncertainties, and may be dependent, in significant part, on the success of our plans to launch new products, as well as successfully continue to promote existing products.

Deferred income taxesare provided for the future tax consequences attributable to the differences between the carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. As of September 30, 2007 and December 31, 2006, we determined that no deferred tax asset valuation allowance was necessary. We believe that our projections of future taxable income make it more likely than not that these deferred tax assets will be realized. If our projections of future taxable income change in the future, we may be required to reduce deferred tax assets by a valuation allowance.

Inventory valuation reserve.At September 30, 2007 our inventory valuation reserve was $3,155,000. Implementation of our returns and inventory optimization plan, in addition to generic competition on certain products, particularly ADOXA^® 150mg tablets, contributed to higher inventory reserves at September 30, 2007. Inventory write-offs were approximately $1,116,000 and $3,523,000, respectively, during the three and nine months ended September 30, 2007. We provide valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. The reserve for estimated inventory obsolescence was

calculated based upon specific review of the inventory expiration dates and the quantity on-hand at September 30, 2007 in comparison to our expected inventory usage. The amount of actual inventory obsolescence and unmarketable inventory could differ (either higher or lower) in the near term from the amounts accrued. Changes in our estimates would be recorded in the statement of income (loss) in the period of the change.

Allowance for bad debts.At September 30, 2007, our allowance for bad debts was $1,777,000. Based upon specific analysis of our accounts receivable, including review of older account balances and account balances resulting in customer short pays, we maintain a reserve. The amount of actual customer defaults could differ (either higher or lower) in the near term from the amounts accrued. Changes in our estimates would be recorded in the income statement in the period of the change.

Results of Operations

Percentage of Net Sales

The following table sets forth certain data as a percentage of net sales for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Net sales	100	%	100	%	100	%	100	%
Gross profit	81	%	84	%	81	%	85	%
Operating expenses	78	%	61	%	75	%	67	%
Write-off of deferred financing costs	10	%	Na		3	%	Na
Operating income (loss)	(6	)%	23	%	3	%	18	%
Interest income	0.8	%	2	%	2	%	2	%
Interest expense	2	%	6	%	5	%	6	%
Income tax expense (benefit)	(4	)%	8	%	(0.5	)%	6	%

Net income (loss)	(4	)%	11	%	(0.4	)%	8	%

Quarter ended September 30, 2007 compared to quarter ended September 30, 2006

NET SALES for the three months ended September 30, 2007 were $33,553,000, a decrease of $1,652,000, or approximately 5%, from $35,205,000 for the three months ended September 30, 2006. The following table sets forth certain net sales data for the periods indicated.

	Three Months Ended				Increase/ (Decrease)		% Change
Therapeutic Category by Company	September 30, 2007		September 30, 2006		Increase/ (Decrease)		% Change
Doak Dermatologics
Dermatology & Podiatry
Keratolytic	$ 6,093,000		$ 4,705,000		$ 1,388,000		30	%
Acne/Rosacea	10,070,000		14,067,000		(3,997,000	)	(28	)%
Actinic Keratoses	7,734,000		5,912,000		1,822,000		31	%
Anesthetics	1,123,000		936,000		187,000		20	%
Scalp	120,000		169,000		(49,000	)	(29	)%
Cosmeceuticals	1,093,000		1,052,000		41,000		4	%
Authorized Generic	(307,000	)	431,000		(738,000	)	(171	)%
Other	41,000		(35,000	)	76,000		217	%

Total Doak Dermatologics	$ 25,967,000		$ 27,237,000		$(1,270,000	)	(5	)%

Kenwood Therapeutics
Gastrointestinal	$ 4,027,000		$ 7,217,000		$(3,190,000	)	(44	)%
Respiratory	1,536,000		453,000		1,083,000		239	%
Nutritional and other	636,000		298,000		338,000		113	%

Total Kenwood Therapeutics	$ 6,199,000		$ 7,968,000		$(1,769,000	)	(22	)%

A. Aarons	$ 1,387,000		$ —		$ 1,387,000		NA

Total	$ 33,553,000		$ 35,205,000		$(1,652,000	)	(5	)%

Doak Dermatologics’ net sales for the three months ended September 30, 2007, were $25,967,000, representing a decrease of $1,270,000, or approximately 5%, from $27,237,000 for the three months ended September 30, 2006. Net sales declines in the acne/rosacea line of products of $3,997,000 were partially offset by increases in the actinic keratoses product line of $1,822,000, due to higher sales of SOLARAZE^®, and the keratolytic product line of $1,388,000. The acne/rosacea decrease included an aggregate decline in ADOXA^® tablet product sales of $7,674,000, as sales of the 50mg, 75mg and 100mg tablets continue to decrease and the Company began to experience generic competition for the first time in the Second Quarter 2007 on the 150mg tablets. Partially offsetting the decrease in the acne/rosacea product line was the Third Quarter of 2007 launch of ADOXA^® 150mg capsules, which had sales of $1,177,000 for the quarter and sales of ROSULA^® CLARIFYING WASH™, which was launched late in the Second Quarter of 2007 and totaled $1,873,000 in sales for quarter. In the keratolytic line of products, sales of KEROL™ TOPICAL SUSPENSION of $2,122,000, launched late in the Second Quarter of 2007, higher sales of KEROL™ REDI-CLOTHS of $1,547,000 and higher sales of the CARMOL^® products of $894,000 more than offset lower sales of KERALAC^® NAILSTIK of $1,718,000 and KERALAC^® OINTMENT of $1,389,000 due to generic competition beginning in the Third Quarter of 2006. In addition to the sales variances described above, profit sharing revenues as reported to us by Par for the Third Quarter 2007 were lower than the prior year by $738,000.

For the three months ended September 30, 2007, Kenwood Therapeutics’ net sales were $6,199,000, representing a decrease of $1,769,000, or approximately 22%, from $7,968,000 for the three months ended September 30, 2006. The decrease in net sales was due to a decrease in the gastrointestinal line of products of $3,190,000, which was partially offset by an increase in the respiratory product line of $1,083,000. The decrease in the gastrointestinal line was led by a decrease in the ANAMANTLE^® HC product family of $3,267,000, which was partially offset by the Second Quarter 2007 launch of a new line extension, PERANEX™ HC CREAM, which totaled $817,000 in net sales for the quarter. Additionally, the PAMINE^® product line also experienced lower net sales of $1,101,000 in the quarter due to generic competition. The respiratory products’ increase was led by higher sales of the DECONAMINE^® products of $758,000, which the Company previously had on backorder due to an inability to secure active ingredient.

Net sales of ELESTRIN™, which was launched late in the Second Quarter 2007 and are included in other under Kenwood Therapeutics in the table above, were $92,000. ELESTRIN™ sales have been slower than originally anticipated due to the use of trade packaging as samples, filling part of the initial prescription demand, and the Company’s process of building relationships with physicians in the women’s health market. According to its prescription data reported by Wolters Kluwer, the Company has experienced an increase in weekly prescriptions for ELESTRIN™ in October 2007 and, although there can be no assurance, expects that sales of the product will increase in subsequent quarters.

In the Third Quarter of 2007, the Company recorded revenues of $1,387,000 from A. Aarons generic product sales based on prescription data and cash collections, while not recording $4,395,000, at gross sales value, for the estimated product remaining in the channel at September 30, 2007. A. Aarons currently does not have an internal sales force and its selling activity is being conducted with the assistance of consultants.

Historically, net sales have been negatively impacted by an increase in generic or therapeutically equivalent products competing on price. The Company experienced generic competition for the first time on ADOXA^® 150mg tablets and ANAMANTLE^® HC GEL during the Second Quarter of 2007 and on ROSULA^® NS and ZODERM^® Redi-Pads during the First Quarter of 2007. In addition, the Company expects, based on its market intelligence, to have generic competition on PERANEX™ HC CREAM in the Fourth Quarter of 2007. The Company’s other products which have recently been negatively impacted by the introduction of generic competition are ANAMANTLE^® HC CREAM KIT (First Quarter 2005), KERALAC^® GEL and KERALAC® LOTION (First Quarter 2005), ZODERM^® (Second Quarter 2005), ROSULA^® AQUEOUS GEL and ROSULA^® AQUEOUS CLEANSER (Second Quarter 2005), KERALAC^® CREAM (Third Quarter 2005), ADOXA^® 50mg and 100mg tablets (Fourth Quarter 2005), ADOXA^® 75mg tablets (Third Quarter 2006), ANAMANTLE^® HC FORTE (Third Quarter 2006), KERALAC^® NAILSTIK (Third Quarter 2006), KERALAC^® OINTMENT (Third Quarter 2006), PAMINE^® 2.5mg and PAMINE^® Forte (Fourth Quarter 2006). We expect our future sales of the above products to continue to be negatively impacted by generic or therapeutically equivalent products.

As noted above, increases in net sales of certain products for the Third Quarter of 2007 were substantially from those that have no generic competition, such as SOLARAZE^®. As with all products that experience generic competition, the Company expects that sales of products that have only recently experienced, or are expected to experience generic competition, including ADOXA^® 150mg tablets, ANAMANTLE^® HC GEL, ROSULA^® NS, ZODERM^® Redi-Pads and PERANEX™ HC CREAM will continue to be negatively impacted in future periods.

As noted above, our net sales for the three months ended September 30, 2007 included certain new product launches. Some of the new product sales were the result of initial stocking sales, which, historically, have resulted in reduced product sales for subsequent quarters.

Our gross prescription demand for the Third Quarter of 2007, based upon information received from Wolters Kluwer, was approximately $50,717,000. Our gross prescription sales, which do not include charges for discounts, returns, chargebacks and rebates, for the Third Quarter of 2007, were approximately $44,351,000. Contributing to the approximate difference of $6,366,000 between gross prescription demand and our gross prescription sales are the following factors: 1) Wolters Kluwer’s projected gross prescription demand is calculated based upon retail sales value while our gross prescription sales are based upon our current gross selling prices; and 2) the timing of our customer purchases, including the effect of our inventory optimization plan, which the Company believes has resulted in a portion of the demand being satisfied by inventory in the channel rather than through new sales.

As stated under “Critical Accounting Policies,” we cannot currently specify exactly when actual returns or credits relate to a current period or prior period, and therefore, we cannot currently specify without utilizing assumptions how much of the provision recorded relates to sales made in the prior periods. However, we believe the appropriate data is available that allows us to reasonably estimate the level of product returns expected from current sales activities, including quantitative and qualitative information such as actual return rates by product, the level of product in the distribution channel, expected shelf life of the product, product demand, the introduction of competitive or generic products that may erode current demand, our new product launches and general economic and industry wide indicators. To determine a reasonable basis for when a returned product may have been sold, we track our returns by lot numbers and compare the lot numbers to when a range of sales may have occurred to determine an estimated average shelf life. We use this historical average as part of our overall process of estimating future returns. We also believe the appropriate data is available that allows us to reasonably estimate the level of credits associated with rebates or chargebacks expected from current sales activities, including quantitative and qualitative information such as the level of product in the distribution channel, the allowance for returns, and historical rebates and chargebacks. To determine a reasonable basis for when a related product rebate or chargeback may have been sold by us, we track our historical rebates or chargebacks by the managed care organizations’ usage period or our receipt date.

The following table summarizes the changes in the return reserve during the three months ended September 30, 2007 and 2006:

	2007		2006
Return reserve at July 1,	$ 22,775,000		$ 27,057,000
Product returns processed in the current
period related to prior period sales (a)	(7,330,000	)	(7,389,000	)
Product returns processed in the current
period related to current period sales (a)	(150,000	)	(150,000	)
Provision for returns relating to current
period sales	7,202,000		5,996,000

Return reserve at September 30,	$ 22,497,000		$ 25,514,000

(a) Based upon our Return Goods Policy and our review of the average time between the sold product lot numbers and return product lot numbers.

The Company’s reserve for product returns at September 30, 2007 decreased from the balance at September 30, 2006. This decrease was primarily due to a reduction in the need to record a provision for current sales due to a pre-established returns reserve in comparison to the estimated inventory in the channel. The Company has implemented initiatives that include lowering customer inventory in the channel and optimizing product production planning to increase effective dating on manufactured products in order to ship products with increased shelf-life to wholesalers (see — “Critical Accounting Policies-Allowance for Returns”). The Company believes that the decrease in customer inventory had contributed to lower revenues in the Second Quarter of 2007 and could also reduce sales in subsequent quarters or while the initiatives continue to be implemented.

As of September 30, 2007, based upon wholesale inventory reports and discussions with retail chains and wholesalers, we estimate the total monthly inventory of our products to be approximately 1.3 months for the primary wholesale customers and 0.9 for all other locations compared 1.4 months for the primary wholesale customers and 0.8 for all other locations as of June 30, 2007, 1.5 months for the primary wholesale customers and 0.9 months for all other locations as of March 31, 2007 and 1.7 months for the primary wholesale customers and 0.9 months for all other locations at December 31, 2006. After applying the September 30, 2007 return reserve, we estimate the unreserved monthly inventory of our products at the wholesalers and retailers to be 0.5 months.

There is no proprietary protection for most of our products, and therefore our products face competition from generic or comparable products that are sold by other pharmaceutical companies. Increased competition from the sale of generic or comparable products may cause a decrease in net sales from our products. If net sales of ADOXA^®, ANAMANTLE^®HC, ELESTRIN™, KERALAC™, PAMINE^®, PERANEX™, ROSULA^®, SOLARAZE^® and ZODERM^® or other Company products decline, as a result of increased competition, government regulations, wholesaler buying patterns, returns, physicians prescribing habits or for any other reason and we fail to replace those net sales, our net sales and profitability would decrease. Further, our net sales and profitability would be adversely affected if, for any reason, we cannot increase sales of ELESTRIN™ or we were unable to launch VEREGEN™ during 2007.

As of September 30, 2007, we had$442,000of orders on backorder as a result of our being out of stock. The Company is in the process of evaluating these orders with customers and we expect to ship and recognize substantially all of these orders in the Fourth Quarter of 2007.

COST OF SALES (exclusive of amortization of intangible assets related to acquired products) for the three months ended September 30, 2007 were $6,273,000, representing a increase of $548,000, or approximately 10%, from $5,725,000 for the three months ended September 30, 2006 primarily due to an increase in inventory write-offs. The inventory write-offs in the Third Quarter of 2007 were $1,116,000, or 2% of net sales, compared to $656,000, or 1% of net sales, in the Third Quarter of 2006. The increase in the current period write-offs was primarily due the establishment of a reserve for ELESTRIN™ due to current forecasts not supporting current inventory levels, generic competition on certain products, particularly ADOXA^®, and increased reserves for A. Aarons products. The gross profit percentage for the three months ended September 30, 2007 was 81% in comparison to 84% for the same period of the prior year. In addition to the increased write-offs, lower profit sharing revenues from Par and lower margins on A. Aaron generic product sales contributed to the lower margin percentage in the Third Quarter of 2007.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended September 30, 2007 were $21,428,000, representing an increase of $2,748,000, or 15%, compared to $18,680,000 for the same period in the prior year. The increase in selling, general and administrative expenses reflects higher spending on salary and salary related expenses, primarily in the sales area, and higher advertising and promotion expenses, primarily related to ELESTRIN™. In selling general and

administrative expenses, the Company has recorded non-cash compensation expense of $783,000 and $776,000, respectively, for the three month periods ended September 30, 2007 and 2006 related to its adoption of SFAS No. 123R,“Stock-Based Compensation” on January 1, 2006. The following table sets forth the (increase) decrease in certain expenditures:

	Change from the Three Months Ended September 30, 2007 in Comparison to September 30, 2006
Advertising and Promotional Costs	$(1,757,000	)
Salary and Salary Related Expenses	(1,120,000	)
Professional fees	407,000
Other	(278,000	)

Total	$(2,748,000	)

In both periods the Company incurred a high level of professional fees. In the Third Quarter of 2007 the Company incurred $2,017,000 in professional fees primarily related to the Company’s ongoing legal matters, including costs associated with independent financial advisors and legal counsel retained by the Special Committee of the Board of Directors to assist it in its work (See NOTEP — Commitments and Contingencies-Legal Proceedings). In the Third Quarter of 2006, the Company incurred legal and advisor fees and expenses of $1,954,000 relating to the proxy contest, which included an accrual for a $1,150,000 settlement fee to Costa Brava.

Selling, general and administrative expenses as a percentage of net sales were 64% for the three months ended September 30, 2007, representing an increase compared to 53% for the same period the prior year. The increase was primarily due to increased marketing costs and salary and salary related expenses without a proportionate increase in net sales.

RESEARCH AND DEVELOPMENT EXPENSES for the three months ended September 30, 2007 were $1,687,000, representing an increase of $1,347,000 compared to $340,000 for the same period in the prior year. The increased research and development costs were primarily due to work on developing ELESTRIN™ samples and potential line extensions of existing products.

DEPRECIATION AND AMORTIZATION EXPENSES for the three months ended September 30, 2007 was $2,900,000, representing an increase of $401,000, or 16% from $2,499,000 for the same period of the prior year primarily due to additional amortization expense from intangibles recorded in the Fourth Quarter of 2006 pursuant to the BioSante and MediGene Agreements.

INTEREST INCOME for the three months ended September 30, 2007 was $276,000 representing a decrease of $425,000 from $701,000 for the three months ended September 30, 2006 primarily due to lower cash, cash equivalents and short-term investments as a result of the Company’s repayment of all its outstanding debt on August 3, 2007.

INTEREST EXPENSE for the three months ended September 30, 2007 was $732,000 representing a decrease of $1,401,000 from $2,133,000 for the three months ended September 30, 2006. The lower expense in the current quarter is due to the repayment of the Company’s outstanding debt as described above.

WRITE-OFF OF DEFERRED FINANCING COSTS for the three months ended September 30, 2007 of $3,256,000 was due to the payment of the outstanding balance under the Company’s old Credit Facility.

INCOME TAX BENEFIT for the three months ended September 30, 2007 was $1,207,000 compared to expense of $2,742,000 for the three months ended September 30, 2006. The decrease in income tax expense was due to a decrease in taxable income. As a result of the adoption of FIN 48 on January 1, 2007 and the effect of permanent tax differences on a smaller taxable base, the Company’s effective tax rate for the three months ended September 30, 2007 increased to 49% compared to 42% in the prior year.

NET LOSS for the three months ended September 30, 2007 was $1,239,000, representing a decrease of $5,025,000 from net income $3,786,000 for the three months ended September 30, 2006. Net loss as a percentage of net sales for the three months ended September 30, 2007 was 4% compared to net income as a percentage of net sales of 11% for the three months ended September 30, 2006. The decrease in net income in the aggregate was principally due to lower net revenues and higher inventory write-offs combined with increased operating expenses and the write-off of deferred financing costs, partially offset by lower net interest expense.

Doak’s net loss for the three months ended September 30, 2007 was $206,000, representing a decrease of $3,887,000, from net income of $3,681,000 for the three months ended September 30, 2006. The decrease in Doak’s net income in the aggregate was principally due to lower net revenues and higher inventory write-offs combined with increased operating expenses and the write-off of deferred financing costs, partially offset by lower net interest expense. Kenwood’s net loss for the three months ended September 30, 2007 was $1,055,000, representing a decrease of $1,232,000 from net income of $177,000 for the three months ended September 30, 2006. The decrease in Kenwood’s net income in the aggregate was principally due to lower net sales combined with increased operating expenses, particularly those related to research and development. A. Aarons, which began operations in the Third Quarter of 2006, had net income of $22,000 for the three months ended September 30, 2007 compared to a net loss of $72,000 in the corresponding quarter of the prior year.

Nine months ended September 30, 2007 compared to nine months ended September 30, 2006

NET SALES for the nine months ended September 30, 2007 were $103,515,000, representing a decrease of $3,593,000, or approximately 3%, from $107,108,000 for the nine months ended September 30, 2006. The following table sets forth certain net sales data for the periods indicated.

	Nine Months Ended		Increase/ (Decrease)		% Change
Therapeutic Category by Company	September 30, 2007	September 30, 2006	Increase/ (Decrease)		% Change
Doak Dermatologics
Dermatology & Podiatry
Keratolytic	$ 16,391,000	$ 16,682,000	$ (291,000	)	(2	)%
Acne/Rosacea	33,418,000	42,138,000	(8,720,000	)	(21	)%
Actinic Keratoses	20,170,000	15,955,000	4,215,000		26	%
Anesthetics	4,118,000	3,506,000	612,000		17	%
Scalp	562,000	957,000	(395,000	)	(41	)%
Cosmeceuticals	3,680,000	3,222,000	458,000		14	%
Authorized Generic	467,000	1,852,000	(1,385,000	)	(75	)%
Other	92,000	109,000	(17,000	)	(15	)%

Total Doak Dermatologics	$ 78,898,000	$ 84,421,000	$(5,523,000	)	(7	)%

Kenwood Therapeutics
Gastrointestinal	$ 15,535,000	$ 19,769,000	$(4,234,000	)	(21	)%
Respiratory	3,986,000	1,778,000	2,208,000		124	%
Nutritional and other	2,453,000	1,140,000	1,313,000		115	%

Total Kenwood Therapeutics	$ 21,974,000	$ 22,687,000	$ (713,000	)	(3	)%

A. Aarons	$ 2,643,000	$ —	$ 2,643,000		NA

Total	$103,515,000	$107,108,000	$(3,593,000	)	(3	)%

For the nine months ended September 30, 2007, Doak Dermatologics’ net sales were $78,898,000, representing a decrease of $5,523,000, or approximately 7%, from

$84,421,000 for the nine months ended September 30, 2006. The decrease in net sales was led by the acne/rosacea line of products of $8,720,000, which was partially offset by an increase in actinic keratoses line of products of $4,215,000, due to higher sales of SOLARAZE^®. The acne/rosacea line of products decreased primarily due to generic competition for the ADOXA^® 50mg, 75mg, 100mg and 150mg tablet products, which in aggregate combined with the current quarter 150mg capsule sales declined by $13,513,000. This decrease was partially offset by increases in ROSULA^® products of $3,118,000, primarily due to sales of the ROSULA^® CLARIFYING WASH™ and ZODERM® products of $1,675,000. Decreases of $9,738,000 in the keratolytic line of products due to generic competition on the KERALAC^® NAILSTIK and KERALAC^® OINTMENT were partially offset by sales of KEROL^™ REDI-CLOTHS and KEROL^TM TOPICAL SUSPENSION of $7,941,000 and increases in CARMOL^®products of $2,979,000. In addition to the sales variances described above, profit sharing revenues as reported to us by Par for the nine months ended September 30, 2007 were lower than the prior year by $1,385,000.

For the nine months ended September 30, 2007, Kenwood Therapeutics’ net sales were $21,974,000, representing a decrease of $713,000, or approximately 3%, from $22,687,000 for the nine months ended September 30, 2006. The decrease in the gastrointestinal line of $4,234,000 was led by a decrease in the PAMINE^® product line of $4,121,000. Decreases in the ANAMANTLE^® HC product family of $3,169,000 were partially offset by the Second Quarter 2007 launch of a new line extension, PERANEX™ HC CREAM, which totaled $1,736,000 in net sales for the year and increased sales of FLORA-Q^® of $1,319,000. Increased net sales in the respiratory line of products of $2,208,000 was primarily due to higher sales of the DECONAMINE^®products, which experienced increase market demand due to the loss of a competitor. Kenwood net sales also included $678,000 for the nine month period from the launch of ELESTRIN™ late in the Second Quarter of 2007.

The Company recorded revenues of $2,643,000 from A. Aaron’s generic product sales for the nine months ended September 30, 2007. The Company began recognizing revenues for A. Aarons in the Second Quarter of 2007 and did not record any revenues for the nine months ended September 30, 2006.

As noted above, our net sales for the nine months ended September 30, 2007 included certain new product launches. Some of the new product sales were the result of initial stocking sales, which, historically, have resulted in reduced product sales for subsequent quarters.

Our gross prescription demand, based upon information received from Wolters Kluwer, for the nine months ended September 30, 2007, was approximately $158,716,000. Our gross prescription sales, which do not include charges for discounts, returns, chargebacks and rebates, for the nine months ended September 30, 2007, were approximately $125,697,000. The approximate $33,019,000 difference between gross prescription demand and our gross prescription sales is affected by the following factors: 1) Wolters Kluwer’s projected gross prescription demand is calculated based upon retail sales value while our gross prescription sales are based upon our current gross selling

prices; and 2) the timing of our customer purchases, including the effect of our returns and inventory optimization plan, which the Company believes has resulted in a portion of the demand being satisfied by inventory in the channel rather than through new sales.

The following table summarizes the changes in the return reserve during the nine months ended September 30:

	2007		2006
Return reserve at January 1,	$ 26,348,000		$ 24,934,000
Product returns processed in the current period
related to prior period sales (a)	(19,085,000	)	(20,536,000	)
Product returns processed in the current period
related to current period sales (a)	(1,436,000	)	(1,546,000	)

Provision for returns relating to current period sales	16,670,000		22,662,000

Return reserve at September 30,	$ 22,497,000		$ 25,514,000

(a)

Based upon our Return Goods Policy and our review of the average time between the sold product lot numbers and return product lot numbers.

COST OF SALES (exclusive of amortization of intangible assets related to acquired products) for the nine months ended September 30, 2007 were $19,630,000, representing an increase of $3,138,000, or approximately 19%, from $16,492,000 for the nine months ended September 30, 2006. Inventory write-offs for the nine months ended September 30, 2007 were $3,523,000, or 3% of net sales, compared to $1,086,000, or 1% of net sales, in the corresponding period of 2006. The increase in the current period write-offs was primarily due to generic competition on certain products, implementation of the Company’s returns and inventory optimization initiatives, including shipping products with increased shelf-life to its customers, the establishment of a reserve for ELESTRIN™ and increased reserves for A. Aarons products. The gross profit percentage for the nine months ended September 30, 2007 was 81% compared to 85% for the same period of the prior year. In addition to the increased write-offs, lower margins on A. Aarons revenue contributed to lower gross margins in 2007.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the nine months ended September 30, 2007 were $65,714,000, representing an increase of $8,102,000, or 14%, compared to $57,612,000 for the nine months ended September 30, 2006. The increase in selling, general and administrative expenses reflects higher spending on salary and salary related expenses, primarily in the sales area, and higher professional fees related to the Company’s ongoing legal matters, a review of matters set forth in a resignation letter from a former employee of the Company and independent financial advisors and legal counsel retained by the Special Committee to assist it in its work (See NOTE P — Commitments and Contingencies-Legal Proceedings). In addition, the Company increased spending on advertising and promotion, primarily related to the launch of ELESTRIN™ late in the Second Quarter of 2007. In selling general and administrative expenses, the Company has recorded non-cash compensation expense of $2,393,000 and $2,625,000, respectively, for the nine month periods ended September 30, 2007 and 2006 related to its adoption of SFAS No. 123R,“Stock-Based

Compensation” on January 1, 2006. The following table sets forth the increase in certain expenditures:

	Change from the Nine Months Ended September 30, 2007 in Comparison to September 30, 2006
Salary and Salary Related Expenses	$(2,994,000	)
Professional Fees	(2,049,000	)
Advertising and Promotional Costs	(1,211,000	)
Other	(1,848,000	)

Total	$(8,102,000	)

Selling, general and administrative expenses as a percentage of net sales were 63% for the nine months ended September 30, 2007 compared to 54% for the nine months ended September 30, 2006. The increase in the percentage was primarily a result of increased spending on professional fees, salary and salary related expenses and advertising and promotion without the proportionate increase in net sales.

RESEARCH AND DEVELOPMENT EXPENSES for the nine months ended September 30, 2007 were $3,317,000, representing a decrease of $2,793,000, or 46%, compared to $6,110,000 for the nine months ended September 30, 2006. The decrease in research and development expenses relates to a $5,000,000 payment made to MediGene in 2006 under the MediGene Agreement in consideration for development and registration activities undertaken prior to the date of the Agreement. The Company expensed the $5,000,000 as a research and development payment during the First Quarter of 2006 since there was no FDA approval at the time of the payment. The lower research and development costs were partially offset by increased work done on potential line extensions of existing products and the cost of developing ELESTRIN™ samples in the current year.

DEPRECIATION AND AMORTIZATION EXPENSES for the nine months ended September 30, 2007 were $8,758,000, representing an increase of $1,180,000 from $7,578,000 for the nine months ended September 30, 2006. The increase was primarily due to additional amortization expense from intangibles recorded in the Fourth Quarter of 2006 pursuant to the BioSante and MediGene Agreements.

INTEREST INCOME for the nine months ended September 30, 2007 was $1,506,000, representing a decrease of $256,000 from $1,762,000 for the nine months ended September 30, 2006 primarily due to lower cash, cash equivalents and short-term investments as a result of the Company’s repayment of all its outstanding debt on August 3, 2007.

INTEREST EXPENSE for the nine months ended September 30, 2007 was $5,284,000, representing a decrease of $1,047,000 from $6,331,000 for the nine months ended September 30, 2006. The lower expense in the current quarter is due to the repayment of the Company’s outstanding debt as described above.

WRITE-OFF OF DEFERRED FINANCING COSTS for the nine months ended September 30, 2007 of $3,256,000 was due to the payment of the outstanding balance under the Company’s old Credit Facility.

INCOME TAX BENEFIT for the nine months ended September 30, 2007 was $550,000 compared to income tax expense of $6,193,000 the nine months ended September 30, 2006. The decrease in income tax expense was primarily due to a decrease in taxable income. As a result of the adoption of FIN 48 on January 1, 2007 and the effect of permanent tax differences on a smaller taxable base, the Company’s effective tax rate for the nine months ended September 30, 2007 increased to 59% compared to 42% in the prior year.

NET LOSS for the nine months ended September 30, 2007 was $388,000, representing a decrease of $8,941,000 from net income of $8,553,000 for the nine months ended September 30, 2006. The net loss as a percentage of net sales for the nine months ended September 30, 2007 was 0.4% compared to net income as a percentage of net sales of 8% for the nine months ended September 30, 2006. The decrease in net income in the aggregate was principally due to lower net revenues and higher inventory write-offs combined with increased selling, general and administrative expenses and the write-off of deferred financing costs, partially offset by lower net interest expense and lower research and development costs.

Doak’s net income for the nine months ended September 30, 2007 was $683,000, representing a decrease of $6,853,000, from net income of $7,536,000 for the nine months ended September 30, 2006. The decrease in Doak’s net income in the aggregate was principally due to lower net revenues and higher inventory write-offs combined with increased selling, general and administrative expenses and the write-off of deferred financing costs, partially offset by lower net interest expense and lower research and development costs. Kenwood’s net loss for the nine months ended September 30, 2007 was $1,113,000, representing a decrease of $2,202,000, from net income of $1,089,000 for the nine months ended September 30, 2006. The decrease in Kenwood’s net income in the aggregate was principally due to lower net sales and higher inventory write-offs combined with increased operating expenses, particularly those related to marketing, amortization and research and development. A. Aarons had net income of $42,000 for the nine months ended September 30, 2007 compared to a net loss of $72,000 in the prior year.

Off Balance Sheet Arrangements

As of September 30, 2007, we did not have any off balance sheet arrangements.

Adoption of New Accounting Standards

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits

of the position. This interpretation is effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. On January 1, 2007, the Company’s adoption of FIN 48 resulted in an opening retained earnings adjustment of $3,500,000.

In June 2006, the EITF issued EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” EITF Issue 06-3 provides guidance related to the presentation in financial statements of any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer, including, but not limited to, sales, use, value added, and some excise taxes. The EITF concluded that the presentation of taxes within the scope of EITF Issue 06-3 on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. In addition, the aggregate amount of any such taxes that are reported on a gross basis should be disclosed in interim and annual financial statements. The guidance in EITF Issue 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The adoption of EITF Issue 06-3 did not have a material impact on the Company’s consolidated financial statements.

New Accounting Standards

In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial position, cash flows, and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. The Company has not yet determined the impact, if any, that the implementation of SFAS No. 157 will have on its results of operations or financial condition.

Liquidity and Capital Resources

Our cash and cash equivalents, short-term investments and restricted cash and investments decreased to $13,126,000 at September 30, 2007 from $71,693,000 at December 31, 2006, primarily due to the payment of the outstanding balance on our old Credit Facility in August 2007. Cash provided by operating activities for the nine months ended September 30, 2007 was $12,749,000. The sources of cash primarily resulted from

non-cash charges for depreciation and amortization of $8,758,000, the write-off of deferred financing costs of $3,256,000 and for the amortization of deferred financing costs of $1,073,000; a decrease in accounts receivable of $3,379,000; non-cash share based compensation expense of $2,393,000; an increase in accounts payable of $2,371,000, due to timing of vendor payments; an increase in the inventory valuation reserve of $2,213,000; an increase in the rebate reserve of $1,582,000; an increase in deferred tax assets of $411,000; and an increase in other accrued expenses of $449,000. The sources of cash were partially offset by a net loss of $388,000; an increase in inventories of $5,280,000; a decrease in the return reserve of $3,851,000; a decrease in prepaid income taxes of $3,204,000; a decrease in allowance for doubtful accounts of $225,000; a decrease in the fee-for-service accrual under DSAs of $104,000; and an increase in prepaid expenses and other of $84,000.

Cash provided by investing activities for the nine months ended September 30, 2007 was $28,300,000. The cash provided by investing activities resulted from the release of a restriction of cash from the old Credit Facility of $25,000,000, from sales of short-term investments-net of $4,074,000 partially offset by the purchase of property and equipment, primarily due to the implementation of a new enterprise computer system, of $774,000.

Cash used in financing activities for the nine months ended September 30, 2007 was $70,541,000, due to payments of $69,060,000 related to the outstanding debt under the old Credit Facility (as described below), the March 2007 payment of $7,000,000 due BioSante for ELESTRIN™ and payments of deferred financing costs of $656,000. These uses of cash were partially offset by proceeds from the exercise of stock options of $5,207,000 and a tax benefit due to exercise of non-qualified options of $968,000.

On August 3, 2007, the Company entered into an amended and restated credit facility, or the New Facility, with a syndicate of lenders led by Wachovia Bank. The New Facility, which replaced the old Facility (as defined below), provides for a $15,000,000 revolving line of credit that is secured by a lien upon substantially all of the Company’s assets, including those of its subsidiaries, and is guaranteed by the Company’s domestic subsidiaries. At September 30, 2007, the Company has $1,125,000 in deferred financing costs, net of accumulated amortization, on its consolidated balance sheet related to the New Facility. These costs are being amortized in interest expense over the length of the agreement. The Company currently has no outstanding debt under the New Facility.

Amounts outstanding under the New Facility will accrue interest at the Company’s choice from time to time of either (i) the alternate base rate (which is equal to the greater of the applicable prime rate or the federal funds effective rate plus 1/2 of 1%) plus an applicable percentage ranging from.75% to 1.25% based on the Company’s leverage ratio, as defined in the amended and restated credit agreement or (ii) a rate equal to the sum of the applicable LIBOR rate plus an applicable percentage ranging from 1.75% to 2.25% based on the Company’s leverage ratio, as defined in the amended and restated credit agreement. In addition, the lenders under the New Facility are entitled to customary facility fees based on unused commitments under the New Facility and outstanding letters of credit.

The financial covenants under the New Facility require that the Company maintain (i) a leverage ratio (which is a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) an interest coverage ratio (which is a ratio of consolidated EBITDA to consolidated interest expense) greater than or equal to 3.00 to 1.00; and (iii) consolidated capital expenditures at less than or equal to $5,000,000 and all consolidated capital expenditures made during the term of the amended and restated credit agreement at less than $12,500,000. The New Facility also limits the Company’s ability to declare and pay cash dividends. As of September 30, 2007, the Company is in compliance with the covenants under the New Facility.

The financial covenants under the old Facility require that the Company maintain (i) a leverage ratio (which was a ratio of funded debt of the Company and its subsidiaries, to consolidated EBITDA) less than or equal to 2.50 to 1.00; (ii) a fixed charge coverage ratio (which was a ratio of (A) consolidated EBITDA, minus consolidated capital expenditures made in cash to (B) the sum of consolidated interest expense made in cash, scheduled funded debt payments, total federal, state, local and foreign income, value added and similar taxes paid or payable in cash, and certain restricted payments) greater than or equal to 1.50 to 1.00; and (iii) not less than $25,000,000 of unrestricted cash and cash equivalents on its balance sheet at all times. Further, the old Facility limited the Company’s ability to declare and pay cash dividends.

On August 3, 2007, concurrently with the closing of the New Facility, the Company repaid the outstanding principalbalance of $62,370,000 under its old Facility. The Board determined that the repayment was an appropriate use of the Company’s existing cash and cash equivalents based on the Board’s desire, among other things, to reduce the Company’s interest expense. In addition, the Company wrote-off $3,256,000 in deferred financing costs in the Third Quarter of 2007 related to the payment of the outstanding balances under the old Facility.

As a result of the FDA approving, in the Fourth Quarter of 2006, the marketing of ELESTRIN™ for the treatment of moderate to severe vasomotor symptoms, especially

hot flashes, associated with menopause, we paid BioSante and its licensor a regulatory milestone payment of $7,000,000 in March 2007 and are required to pay an additional $3,500,000 in December 2007. At September 30, 2007, the remaining $3,500,000 regulatory milestone payment is non-interest bearing and classified as milestones payable of $3,252,000 utilizing an imputed interest rate of 7.35% to determine the principal owed. In the Second Quarter of 2007, we launched ELESTRIN™ and are paying BioSante a royalty on net sales.

As of September 30, 2007, we had the following contractual obligations and commitments:

Period	Operating Leases	ELESTRIN™ Payments	Minimum Inventory Purchases (a)	Total Obligations and Commitments
Oct. 1, 2007 to Dec. 31, 2007	$ 532,000	$3,500,000	$ 128,000	$ 4,160,000
Fiscal 2008	1,827,000	—	1,900,000	3,727,000
Fiscal 2009	1,476,000	—	800,000	2,276,000
Fiscal 2010	962,000	—	267,000	1,229,000
Fiscal 2011	791,000	—	—	791,000
Thereafter	926,000	—	—	926,000

	$6,514,000	$3,500,000	$ 3,095,000	$13,109,000

(a)

For more information on minimum inventory purchases, see “Manufacturing and Supply Agreements” in NOTE K.5 of the notes to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended 2006.

We believe that our cash and cash equivalents and cash generated from operations together with funds available under the New Facility will be adequate to fund our current working capital requirements for at least the next twelve months, including the costs and expenses associated with our anticipated launch of VEREGEN™ and our ongoing launch of ELESTRIN™. However, if we make or anticipate significant acquisitions, we may need to raise additional funds through additional borrowings, by other means or the issuance of debt or equity securities.

Impact of Inflation

We have experienced only moderate price increases under our agreements with third-party manufacturers as a result of raw material and labor price increases. We have passed these price increases along to our customers. However, there can be no assurance that possible future inflation would not impact our operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

During the period from our fiscal year end, December 31, 2006, to the end of our third fiscal quarter, September 30, 2007, there have been no material changes in the information previously provided under “Part II, Item 7A: Qualitative and Quantitative Disclosures About Market Risk” set forth in our Annual Report on Form 10-K for the year ended December 31, 2006.

Item 4. Controls and Procedures

The Audit Committee of the Board of Directors of the Company has reviewed this Quarterly Report on Form 10-Q.

Evaluation of Disclosure Controls and Procedures

The Company is required to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) as appropriate, to allow timely decisions regarding required disclosure.

In connection with the preparation of the Form 10-Q for the period ended September 30, 2007, management, under the supervision of the CEO and CFO, conducted an evaluation of disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2007.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended September 30, 2007 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Contract Disputes

Shareholder Lawsuits

Additionally, two related New Jersey state court shareholder derivative actions were filed on April 29, 2005 and May 11, 2005 against certain of the Company’s officers and directors alleging breach of fiduciary duty and other claims arising out of substantially the same allegations made in the federal securities class action lawsuit. Plaintiffs seek an unspecified amount of damages in addition to attorneys’ fees. On the parties’agreement, these two related state shareholder derivative actions were consolidated on July 19, 2005 in the Superior Court of New Jersey. Plaintiffs in the state shareholder derivative actions filed a consolidated amended derivative complaint on May 12, 2006. The Company and the individual defendants filed its initial response on July 17, 2006 seeking to dismiss the alleged derivative complaint in its entirety with prejudice. On October 30, 2006, the court granted the defendants’ motion to dismiss and dismissed

the derivative complaint with prejudice. Plaintiffs filed a notice of appeal on December 14, 2006 and their appeal papers on April 27, 2007. Briefing on the appeal was completed on June 21, 2007. Oral argument on the appeal was held on October 23, 2007. The Court has not yet ruled on the appeal.

SEC Inquiry

In December 2004, the Company was advised by the staff of the SEC that it is conducting an informal inquiry relating to the Company to determine whether there have been violations of the federal securities laws. In connection with the inquiry, the SEC staff has requested that the Company provide it with certain information and documents, including with respect to revenue recognition and capitalization of certain payments. The Company is cooperating with this inquiry, however, the Company is unable at this point to predict the final scope or outcome of the inquiry, and it is possible the inquiry could result in civil, injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions. The conduct of these proceedings could negatively impact the Company’s stock price. Since the Company cannot predict the outcome of this matter and its impact on the Company, the Company has made no provision relating to

this matter in its financial statements. In addition, the Company expects to continue to incur expenses associated with the SEC inquiry and its repercussions, regardless of the outcome of the SEC inquiry, and the inquiry may divert the efforts and attention of the Company’s management team from normal business operations. During the Second Quarter 2006, the Audit Committee completed its previously announced internal review related to the SEC’s informal inquiry. The Audit Committee conducted its review with the assistance of independent counsel. The Audit Committee’s conclusions were delivered to the full Board of Directors, the SEC and the Company’s independent accountants.

General Litigation

The Company accounts for legal fees as services are incurred.

Item 1A. Risk Factors

The material changes in the information previously provided under “Part I, Item 1A: Risk Factors” set forth in our Annual Report on Form 10-K for the year ended December 31, 2006 are described below. Refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

We may suffer negative consequences if the proposed Merger with a subsidiary of Nycomed US is not completed.

The effect on us and our stockholders if the Merger with Nycomed US were not to be completed could have a material adverse effect on our business prospects and financial condition, including the likelihood that in such event, the price that might be received by our holders of common stock in the open market could be less than the per share cash price to be paid in the Merger. If the Merger is not completed or the Merger Agreement is terminated, we will be subject to a number of material risks, including:

•

the provision in the Merger Agreement that provides that under specified circumstances we could be required to pay to Nycomed US a termination fee equal to 3% of the Merger Consideration (as defined in the Merger Agreement);

•

the market price of our common stock may decline to the extent that the current market price of such shares reflects a market assumption that the Merger will be completed;

•

costs related to the Merger, such as legal and accounting fees, must be paid even if the merger is not completed;

•

the impact of the reason or reasons for which the Merger Agreement was terminated and whether such termination resulted from factors adversely affecting us;

•

the diversion of management attention from our day-to-day business and the unavoidable disruption to our employees during the period before the completion of the Merger may make it difficult for us to regain our financial position if the Merger does not occur;

•

if the Merger Agreement is terminated and our board of directors seeks another merger or business combination, we cannot be certain that we will be able to find a partner willing to pay an equivalent or more attractive price than the price to be paid by Nycomed US in the merger; and

•

employees important to our success as a stand-alone company may have left in anticipation of the Merger.

We intend to file a proxy statement with the SEC that, when final, will contain important information about us, the merger, the risks relating to the merger and related matters.

Our directors and officers may have interests in the proposed Merger that may be in addition to, or different from, the interests of our other stockholders.

Some of our directors and executive officers have interests in the Merger that may be in addition to, or different from, the interests of our stockholders generally. These interests may present them with actual or potential conflicts of interest and may entitle them to certain benefits in connection with the proposed Merger to which our other stockholders may not be entitled. For example, each of our existing employment agreements with our executive officers provides that, if such executive officer is terminated for “cause” or resigns with “good reason” (as described in the applicable employment agreement) within prescribed time periods prior to or following the consummation of a “change of control” (as described in the applicable employment agreement), including the proposed merger, such executive officer will be entitled to certain cash severance payments and the continuation of certain benefits for a period of time, and accelerated vesting of all unvested stock options previously granted to such executive officer under our stock option plans. In addition, the Merger Agreement provides that our officers and directors will be indemnified by Nycomed and us against certain liabilities and that directors’ and officers’ liability insurance will be maintained on behalf of our directors and officers following the effective time of the merger. We intend to file a proxy statement with the SEC that, when final, will contain important information about us, the merger, risks relating to the merger and related matters, including addition information regarding the interests of our officers and directors in connection with the proposed merger.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits.

Exhibit No.

Description

10.1

Amendment to Distribution Services Agreement, dated as of August 1, 2007, by and between the Company and Cardinal Health.*

10.2

Amendment Extension and Novation of Core Distribution Agreement, dated as of October 5, 2007, by and between the Company and McKesson Corporation.*

31.1

Rule 13a-14(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Rule 13a-14(a) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification pursuant to 18 U.S.C. Section 1350 by the Chief Executive Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification pursuant to 18 U.S.C. Section 1350 by the Chief Financial Officer, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Confidential treatment has been requested for certain portions that have been omitted in the copy of the exhibit filed with the SEC. The omitted information has been filed separately with the SEC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	BRADLEY PHARMACEUTICALS, INC. (REGISTRANT)

Date: November 8, 2007	/s/ Daniel Glassman Daniel Glassman President and Chief Executive Officer (Principal Executive Officer)

Date: November 8, 2007	/s/ R. Brent Lenczycki, CPA R. Brent Lenczycki, CPA Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Bradley Pharmaceuticals (BPRXL) Inactive 10-Q2007 Q3 Quarterly report

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